Investors focus on trade and Fed policy risks, as company earnings for Q1:2019 remain supportive
The US earnings season is well underway, with 78% of the S&P500 (392/505) companies having reported Q1:19 results so far.
Specifically, starting from the top-line performance, revenue growth is on par with early April consensus expectations so far, increasing at an annual rate of 5.4% in Q1. The increase is well-balanced, with 9 of the 11 major S&P500 sectors reporting a positive outcome, led by healthcare (+14.8%). 60% of companies have exceeded analysts’ expectations. Sales growth is expected to slow slightly in the following quarters, tracking a +4.9% yoy rise for 2019, above its 5Yr average pace of 4.2% (2014-2018), and following a strong 2018 (+10.3%).
Top line growth remains resilient, but net profit margins appear to be faltering (11% est. in Q1:19), after peaking in 2018 (12% in Q3:18). Higher input costs (labor costs, wages, raw materials) could be affecting companies’ bottom lines. Nevertheless, margins remain healthy and are expected to stabilize (even increase gradually) during 2019, broadly offsetting slowing sales growth.
Regarding earnings, recall that expectations for Q1 had been clouded by economic and geopolitical uncertainty at the beginning of the season. Analysts initially (early April) expected a strong decline of -4.1% yoy for Q1. So far, however, estimates have been revised to -0.8% yoy. Indeed, positive earnings revisions for consumer discretionary, materials and financials largely account for this change, while overall, 76% of companies have overshot consensus EPS estimates (by +5.6% on average).
Nevertheless, a negative yoy EPS outcome would mark the first EPS contraction since Q2:16. Furthermore, despite improved Q1 prospects, expectations for the coming quarters were revised down (Q2/Q4:19 average expected pace: +2.3% yoy vs +3.6% in early April), following weak company guidance for Q2. Indeed, the percentage of companies issuing negative guidance is at 80% vs a 5Yr average of 70%. As a result, consensus estimates for 2018/2019 EPS growth continue to point to low single-digit growth of circa +3.6%, based on $168 EPS level (see graph below).
Overall, we maintain, for now, a constructive view on equities, as earnings fundamentals remain supportive and assuming that trade risks do not re-emerge (see below). US recession fears have faded, following better-than- expected GDP growth (3.2% qoq annualized up from 2.2% in Q4:18) and an improved labor market (UR: -0.2 pps at 3.6%). Moreover, equity markets could overcome the end of the Fed’s dovishness. Note that Chair Powell sounded slightly hawkish at the FOMC meeting on May 1st, suggesting that the inflation undershooting is likely transitory, while ruling out an “insurance” cut in the Federal Funds rate as happened in 1998.
However, the main obstacle (risking occasional corrections) remains the US-China trade policy, with President Trump suggesting the imposition of increased tariffs of 25% (from 10%) on $200bn goods as early as Friday, on the back of slow progress on talks. Global equities (MSCI ACWI: +0.2% wow | +15.2%) declined sharply on Monday, as trade concerns prevailed. China’s CSI 300 index recorded losses of 5.8% and the EuroStoxx index was down by 1.2%, while safe-haven assets rallied, with 10Yr German Bund yields declining by 2 bps (to 0.01%) and the JPY up by 0.3% against the USD to $110.75.