The sugar rush fades: corporate earnings will underpin future stock market movements

clock • 3 min read

Industry Voice: We're in the midst of US corporate earnings season. Analysts are expecting overall year-on-year profit growth of around 15%, with some sectors, such as energy and industrials, exceeding that.

Much, though not all, of this is due to the sugar rush provided by President Trump's tax cuts. This has propelled earnings growth towards 25% in recent quarters. But now the rush is starting to fade. So a key question for this earnings season and for 2019 is how quickly those extraordinary growth levels will fall away.

We expect company profits to stabilise around the mid-single digits. This would be a necessary if not sufficient condition for equity markets to make progress this year. Management guidance will be important in helping us to understand any slowdown. It will also give us insights into how companies are dealing with challenges like trade tensions, heightened regulation, disruptive technology and changes to their supply chains.

Those challenges have weighed on the stock market recently, with equity investors entering this year in a particularly bearish mood. But markets have since regained some ground on hopes that the Federal Reserve will be more cautious and Presidents Xi and Trump more amicable.

The earnings season should help us judge whether that rally is warranted and sustainable, or whether investors are being overly optimistic.

In particular, the results should allow us to assess exactly what impact the trade war is having on US companies - especially through its effect on the Chinese economy. The revisions to Apple's guidance have been taken as a general sign that the impact of Trump's tariffs is beginning to feed back to US companies, although fundamental changes to the smartphone cycle also mattered.

In truth, the revisions did not come as a big surprise. We have seen plenty of evidence on the ground in Asia from Apple's supply chain that pointed to lower-than-expected iPhone production, and the company confirmed that the trade war was only partly to blame. Still, the extent to which the trade war is coming back to bite broader parts of corporate America should become clearer during this earnings season.

The S&P500 conference calls will also help us to build a better picture of how the US economy is faring, which in turn will influence the direction of the Federal Reserve's monetary policy. The Fed has clearly indicated that it is much more in listening mode now and is wary of the impact of tightening financial conditions further. So equity and indeed bond markets will be eagerly extrapolating from management guidance to try and build a better picture of which way the Fed will turn.

Margin compression is particularly important here. There are a number of moving parts: sales growth may be holding up well, but there are pressures from mounting labour costs while regulation plays a role in some sectors. These factors are offset, however, by a helpful improvement in productivity growth even this late in the cycle.

This won't be a stellar earnings season. But it will be an influential one. The best of the gains from the Trump tax cuts are behind us, and the outlook for companies is fogged by some major uncertainties. The risk is that firms use the recent sell-off to lower the bar for next year, which would be worrying. But there should be sufficient momentum to deliver decent profits growth for the time being. And when investor sentiment has been so depressed, even a modicum of good news can encourage risk-averse investors to put their cash to work.

 

Read the article on Abderdeenstandard.com

 

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