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Third quarter could mark turning point in U.S. profit cycle

Stock Markets Sep 30, 2019 12:10PM ET
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By Caroline Valetkevitch

NEW YORK (Reuters) - As investors prepare for U.S. corporations to report financial results next month, they could look past recent sluggish growth and find comfort as earnings look set to rebound after the third quarter.

Profits were strong throughout 2018 because of the tax windfall, so comparisons to those earnings periods mean growth has been relatively more muted this year.

Those comparisons will get "easier" in Wall Street parlance in coming months, with the third quarter set to mark a low point in the recent earnings cycle.

Moreover, easing monetary policies both here and abroad are likely to provide a cushion for companies despite slower economic growth, especially in the face of a lingering trade war between the United States and China.

To be sure, some of those profit gains will depend on whether the economy does hold up, and experts say that is far from certain. Recent economic data has been mixed, with reports on U.S. labor and housing upbeat, but others disappointing.

Data Friday was in the latter camp. It showed U.S. consumer spending barely rose in August and the business investment remained weak, and some strategists consider the Trump administration's nearly 15-month trade war with China to be among the biggest risks to the economy and earnings.

Still, some strategists argue that just a small amount of economic growth should be enough to support better profit growth, which could help justify high market valuations.

"People are overestimating the negative from trade and underestimating the lagged response from a lot of policy easing," said Jim Paulsen, chief investment strategist at The Leuthold Group in Minneapolis.

"It could affect what corporations say when they look ahead," he said.

The Federal Reserve has just begun to lower interest rates in the United States but other countries are further along in their easing cycles.

For the quarter that ends Sept. 30, analysts are forecasting S&P 500 earnings to fall 2.2% from a year ago, based on IBES data from Refinitiv, putting the period on track to be the lowest quarterly profit performance since 2016.

(GRAPHIC - S&P 500 profit performance since 2015: https://fingfx.thomsonreuters.com/gfx/mkt/12/6749/6680/Pasted%20Image.jpg)

Analysts were projecting earnings declines in both the first and second quarters, too, but those quarters ended with some profit growth, according to Refinitiv's data, and that could be the case for the third quarter as well.

While fourth-quarter earnings estimates have fallen sharply in recent months and strategists expect 2020's forecasts will come down as well, the last quarter of 2019 is still estimated to show profit growth of 4.1%. And earnings are forecast to grow 11.2% in 2020.

Many investors are hopeful that earnings, which begin in mid-October with reports from JPMorgan Chase (N:JPM) and other banks, will take some of the focus away from recent political turmoil, including Democrats' formal impeachment inquiry against President Donald Trump.

The Cboe volatility index (VIX) ended Friday at a three-week high.

"It's good that earnings are coming ... At least then we'll have some concrete data to go on," said Susan Schmidt, head of securities and portfolio manager at Aviva (LON:AV) Investors Americas in Chicago. "we don't expect good things to come out of this earnings season. I think we're going to hear toned-down guidance."

Results could offer some positive surprises.

According to most forecasts on Wall Street, the trajectory for earnings is still upward after the third quarter, said Jill Carey Hall, a U.S. equity strategist at Bank of America Merrill Lynch (NYSE:BAC) in New York.

"If we see any positive news on trade, and if corporates have been successful in mitigating some of the pressures, that could help reaffirm expectations of a pickup in profit growth," she said.

Third quarter could mark turning point in U.S. profit cycle
 

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