Chart of the week: Reading the early warnings on earnings

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As the latest US earnings seasons moves into high gear, investors should pay more attention to what companies are saying about their future earnings than to the current results. Changes to such guidance should provide clues to the earnings growth potential in 2020.

  • The early indications: last week, out of 24 companies, four raised their 2020 guidance, 15 lowered it. If this pattern – similar to what we saw in Q4 2018 – continues, the equity market is at risk
  • Quarterly earnings growth likely flat year-on-year

Expectations for US company earnings in Q3 2019 and Q4 2019 are quite low – as they were for Q2 2019. Growth rates are inevitably lower now because tax cuts boosted year-ago profits. In addition, from last December to this February, equity analysts downgraded their earnings expectations, particularly for the energy and technology hardware sectors. We expect earnings growth will not return to trend until Q1 2020.

The Q3 results we have had so far signal that analyst forecasts for 2020 may largely be met: the earnings growth rate to date stands at 6.1% (ex-semiconductors). For financials, earnings per share (EPS) have risen by only 4.6%, but that may be as much as can be hoped for given the low interest rates. To counterbalance that, reported Q3 industrial sector earnings have risen by 11.5%.

So, for the quarter, we could well end up with around flat year‐on‐year earnings growth, instead of the current forecast for a contraction. However, even a better-than-expected earnings growth rate will not be enough to drive the market as a whole much higher if that growth rate is near zero.

What is next matters more

The earnings growth that markets will need to actually advance is not forecast to come until 2020, so company guidance on the outlook for profits is now particularly important. Here the signs are more mixed. In Exhibit 1, the green line shows a recent, sharp drop in guidance.

Exhibit 1: Earnings guidance and S&P 500 diverge

Positive guidance as percent of total

Exhibit 1: Earnings guidance and S&P 500 diverge

Data as at 21 October 2019. Note: Count refers to number of companies reporting. Source: Bloomberg, BNP Paribas Asset Management

If there is yet more poor guidance, the risk is a repeat of the Q4 2018 pattern. Then, significant earnings disappointments drove the market, and subsequently earnings expectations, lower.

So far this year, the gains in US and European equity markets have come from the decline in the risk premium and in interest rates rather than earnings expectations. Such declines cannot sustainably support markets. While returns for equities through the end of 2020 will depend on each of these factors, the role of earnings will have to expand to safeguard upside.


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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

Daniel Morris

Senior investment strategist, CFA charterholder

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