The earnings showdown
A variety of factors may have an impact on corporate earnings results in 2019. Read on for what KC Mathews, executive vice president and chief investment officer at UMB Bank, thinks about the situation – and how it could affect you.
Numerous economic and market showdowns may lead to a corporate earnings slowdown. In 2018, fiscal stimulus boosted earnings growth to approximately 22%. This year, expected earnings growth, given the current guidance from S&P 500 companies, is 8%. UMB anticipates S&P 500 growth in the 5-7% range and believes there are risks to the downside.
Potential showdowns that lead to corporate earnings slowdown
- Trade tensions – Approximately 30% of S&P 500 earnings come from overseas. Tariffs and ongoing trade tension will increase input costs and reduce margins. Plus, pricing power is scarce in most industries. As a result, earnings growth is at risk until uncertainty is mitigated and there is some type of trade resolution.
If a trade deal is agreed upon, U.S. multinational companies could be the beneficiaries as trade volume increases and costs are reduced as tariffs are removed.
- Transition of the global economy – From 2016 to 2018, the global economic theme was synchronized growth. Today, the theme is transitioning to synchronized global slowdown. This could negatively impact earnings since 40% of S&P 500 revenues come from overseas. The global purchasing manufacturing index has deteriorated significantly, similar to the slowdown in 2011-2012 and 2015-2016 when U.S. corporate earnings went into a recession, contracting for seven quarters.
- Federal Reserve action – In late 2015, when the Fed was indicating that the rate tightening cycle was about to begin, the equity markets sold off. In October 2018, the Fed suggested it would continue to move rates higher and the Dow Jones sold off 840 points. Higher interest rates can negatively impact economic activity and corporate financing costs.
It appears the Fed is exercising a tactical pause, similar to 2016. In early 2016, the Fed suggested they would hike four times throughout the year. As the economic data indicated slowing conditions and corporate earnings evaporated, the Fed paused and only hiked once in December 2016. We anticipate similar Fed action given the very moderate data.
- Inflation – Headline inflation has gone down since mid-2018, although it’s important to note that some inflation is good for corporations as it allows them to increase prices. Today, the perfect storm is developing: There is little headline inflation so companies in general don’t posses any pricing power, yet wage inflation is on the rise. Average hourly earnings are up 3.4%, increasing costs for corporations and potentially reducing earnings. New York City has a $15 minimum wage for city workers; Amazon, Costco, Target and Walmart all have minimum wages substantially higher than state laws require. This puts pressure on other smaller companies to have competitive wages to retain and attract labor.
Last year, corporate America received a gift in the form of tax reform, which boosted corporate earnings. This year, numerous risks have put pressure on earnings, increasing the probability of another earnings recession. In 2019, we expect 5-7% earnings growth supporting equity total returns in the 10-14% range.
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