Published August 2, 2019
As earnings roll in for the quarter, we post an article from Josh Brown that highlights analysis done by David Kostin at Goldman Sachs discussing the outlook for earnings growth.
Here is Josh’s article:
This year there has been concern over “negative earnings growth” or the idea that the earnings and sales growth of 2018 was declining. It’s important to remember that in 2018 we had a one-time tax cut benefit that allowed S&P 500 companies to report lower effective tax rates and show an “instant” profitability spurt; this sort of thing was never going to be repeated in 2019. The corporate tax cut was made official in December 2017, and the S&P 500 had already spent the entire year anticipating it with a huge run-up in share prices. Then, in 2018, it took effect, and we had two double-digit selloffs as the tax cut became official and went into effect (one in February and then another that stretched from September through Christmas Eve – this one falling all the way down 20% to produce the requisite “bear market” headlines).
It’s not ironic that earnings and sales growth were incredible throughout 2018 while the index closed the year down 5%. Stocks are anticipatory; prices reflect people’s opinions about the future, not the present.
Let’s turn our attention to this year and beyond…
Goldman Sachs strategist David Kostin is out with a note looking at the outlook, and what he sees are continued gains in earnings and revenues and economic activity. But it’s plain to see that 2018 represented a statistical growth rate peak. See the charts below, which show actual plus expectations going forward:
So you’re not going to get a return to 9% revenue growth or 23% earnings per share growth this year or next, because you’re not getting another massive, one-time tax cut. Anyway, the important thing was to understand that, yes, of course the earnings comparisons were going to generate a deceleration. Harder to imagine, however, was whether or not investors would “see through the valley” and react well to these declines in growth rates. They did in fact react well. Who knew?
The message here is that stocks and the economy can continue to grow on past the peak, even if it is more reasonable to expect them to do so slowly. Here’s Kostin’s outlook, which is reasonable and should be supportive of at least current stock market valuations, absent any sort of exogenous event:
We expect S&P 500 EPS will grow by 3% in 2019 and by 6% in 2020. Our top-down EPS estimates are generally in line with bottom-up consensus estimates in 2019 ($167 vs. $166), but well below consensus estimates in 2020 ($177 vs. $184). We forecast sales growth of +5% and +4% in 2019 and 2020, roughly in line with nominal US GDP growth and slightly below consensus estimates. We forecast margins will fall by 0.4% in 2019 but rebound slightly in 2020 as economic growth improves.
We lower our 2019 EPS estimate by $6 and growth by 3 percentage points, given weakness in economic activity and the margin outlook. Since January, we have noted that 2019 EPS growth would likely equal between 3% and 6%. Halfway through the year, economic growth has been below-trend, oil prices have been range-bound, and tariff uncertainty has not abated. We therefore expect that 2019 EPS growth will equal 3%, the low end of the range. Most of the change in our earnings estimate is driven by weaker-than-expected economic activity, oil prices, and margins, particularly within semiconductors.
So, technically, yes, we are seeing a “deceleration.” It was easy to have foreseen that the one-time benefit of tax reform was not going to repeat – but that this did not spell doom for the stock market or the economy.
The next test will be whether or not share prices handle things well as consensus forecasts for full-year 2019 come down at firms up and down Wall Street. The good news is that this happens almost every year – the most bullish outlooks are always published in December and, as Kostin remarks, it is after Q2 reports are out that analysts begin to chop down the full-year estimates. That will be happening in the coming weeks.
Investors looked to the latter half of the week with the Federal Reserve meeting announcement on Wednesday and the monthly jobs report on Friday. Monday’s session was quiet with defensive sectors showing some strength. The broad market dipped -0.2%. Solid earnings reports from Merck (MRK) and Procter & Gamble (PG) provided good news Tuesday morning. However, investors appeared cautious ahead of Apple’s earnings announcement after the close. Stocks slid another -0.3% during Tuesday’s session while small-caps rose over +1% in a positive development. Apple (AAPL) delivered good news for investors sending that bellweather stock higher by +2%. However, the Fed announcement overshadowed that good cheer. The Fed delivered the expected -0.25% drop in short-term interest rates but disappointed markets by failing to suggest future rate cuts. Stocks slumped on the news, falling -1.1% in Wednesday’s trade to close out the month of July with a +1% result. Thursday saw markets bounce back strongly to recover the entirety of the Fed-induced loss. But an afternoon announcement of further tariffs on China surprised investors undoing the rally and sending shares sharply downward. Stocks closed down -0.9% after being higher by more than +1%. Oil prices dove -7.5% while investors flocked to the safety of U.S. Treasury bonds. The yield on the 10-year U.S. Treasury bond slammed under 2% to close at 1.9%. Friday saw a continuation of the selling as investors ignored a solid employment report. Stocks tumbled almost -2% during the day before working their way back to a -0.7% closing loss.
Stocks ended up with their worst weekly slide since the dismal month of May with the S&P 500 falling -3.11%. The Nasdaq 100 (QQQ) suffered a -4.07% drop. Small-caps, which broke higher early in the week, joined the other indexes with a -2.94% tumble.
Warm wishes and until next week.