The good news on 2019 earnings is that a lot of bad news is already priced into the market, as seen by the very modest drop of 1.5 percent in Samsung shares on Tuesday after terrible guidance.
The flip side is a lot of damage has already been done, and other companies will be similarly cautious. It’s not clear how much negative news the markets can handle before again turning down.
For some bears, like Mike Wilson from Morgan Stanley, the damage to the global economy has already been done: “I don’t see how the earnings revision trajectory is going to turn positive,” he said on CNBC on Tuesday.
Early fourth-quarter earnings reports — not surprisingly — are coming in above expectations, but investors have only one issue on their minds: 2019 guidance. Of the 18 companies that have reported fourth-quarter earnings, 94 percent have beaten expectations, but 67 percent have had their first-quarter earnings estimates cut by analysts after their reports. according to Nick Raich at Earnings Scout.
Most importantly, overall numbers for 2019 are declining: from 10 percent earnings growth for the S&P 500 in 2019 projected at the start of October to a lower 6.8 percent projection as of now.
Where are the cuts coming from? The negative comments from Samsung, Apple, Micron and LG Electronics have cut the profit growth forecast for the technology sector in half for 2019: Profit growth estimates for financials have also come down.
November: up 5.2 percent
January: up 2.6 percent
Energy is another big decliner: With oil prices dropping like a stone in the fourth quarter, estimates for oil company profit growth were slashed dramatically.
November: up 21.3 percent
January: up 5.6 percent
But how much should be cut?
Investors fall into one of two camps: Those who believe earnings growth could be flattish in 2019, and those who think earnings will grow in the mid-single digits.
The difference is not trivial, according to Raich: “If earnings we go to 4 or 5 percent for 2019, that’s a good thing and the markets will reset higher. If it goes to zero, that’s not good.”
For Raich, the drop in stock prices in the fourth quarter was simply a response to the deteriorating macro environment. “More companies are lowering estimates and by a greater amount. The good news is that the markets are pricing this in,” he said.
It certainly seems that way. Look at the very mild response to Samsung’s very poor guidance. Had that announcement happened in October, shares of Samsung and semiconductors would have been down far more.
But with prices down, valuations look a lot more attractive. That’s the message from the Wharton School’s Jeremy Siegel, noting that the S&P 500 is now trading at a roughly 16 multiple to 2019 earnings: “Now, that’s not a very high multiple,” he said on CNBC on Tuesday. “So, even if there’s no earnings growth, you’re not paying up prices for stocks, you’re not valuing the market at anything that’s a crazy valuation.”
For Raich, the key to getting positive earnings growth lies first with the Federal Reserve’s actions on interest rates. “The Fed needs to back off, otherwise growth estimates will go to zero,” he said.
The second issue for earnings is trade. “The trade conflict is creating an overhang on CEO confidence,” Raich said. “It’s more of the psychology of what an overhang does to capital spending plans.”