Quarterly earnings for the are expected to decline for the first time since the second quarter of 2016, even though the index is just 2% from its historic high.
First-quarter earnings for the S&P 500 are projected to decline 2.5% from last year, according to Refinitiv consensus estimates.
Stocks up with earnings down? To Nick Raich at Earnings Scout, it is a reason to be a bit cautious: "At the minimum, it indicates the market could be very sensitive to macro events like tariffs or slower global growth."
Stocks are rising even with lower earnings because of the focus on the future, not the past. The stock market is a discounting mechanism for a future stream of earnings.
The "bull narrative" is still dominant on Wall Street — that China and Europe are bottoming — and this will stabilize markets. Raich puts it simply: "The markets have gone from pricing in negative growth in the first half to rapidly re-accelerating growth in the fourth quarter and the beginning of 2020."
Many industries that were under pressure in the fourth quarter — think semiconductors — have snapped back in 2019 on the "bottoming" story. Major semiconductor supplier Samsung, for example, said in January that demand would recover in the second half of the year, and Wall Street has bought into that story.
Flat or declining earnings don't necessarily mean the stock market is in trouble. First, there is a good chance earnings for the first quarter will turn positive. Because guidance is usually conservative, most companies end up beating analyst estimates. On average, the earnings surprise for the S&P 500 is about 3 percentage points.
Earnings are now expected to be down 2.5%, so if the historical average holds and the final estimate is 3 percentage points higher, earnings will be slightly positive, up 0.5%.
Second, declining earnings do not necessarily correlate with a decline in the stock market. There have been many times where earnings have been flat or declined and even when the market declined, it quickly bounced back (this happened in the first part of 2016). The reason: No recession followed.
And that's the key: What side of the recession debate are you on? If you believe there will be a recession in 2020, then earnings will certainly decline and go negative, along with the stock market.
But it's not at all clear that will happen.
As earnings recessions go, this one is pretty modest so far. It looks more like flat earnings growth after a torrential two-year run. Second-quarter earnings are also looking flattish to slightly down.
There are still some worrisome trends. One troubling point: First-quarter earnings for the S&P 500 are projected to decline 2.5% from last year, but revenues are expected to be strong — up 4.8%.
To David Aurelio, who covers corporate earnings for Refinitiv, it's a sign of margin erosion in some key industries.
"You have pricing pressure and cost increases," he said. "You have some degree of labor increases, transportation costs, and material costs, as well as some impact from tariffs. You are also definitely seeing pricing pressure, particularly in technology, where there has been pressure on semiconductor prices and even Apple's phones."
The sectors that are seeing the biggest earnings declines are sectors where there is pricing pressure, cost increases, or some combination. Most important is the market leader — technology — which is expected to see a notable decline in earnings (6.1%), along with materials.
In technology, look no further than semiconductors (earnings are projected to plunge 19.2%) and hardware/storage, where earnings are expected to fall 17.1%. These are the two sectors suffering from the highest degree of price competition and supply overhang.
Same with energy, which is forecast to suffer an earnings decline of 21%. While oil has recovered after a dramatic fourth-quarter drop, prices started 2018 over $60; going into 2019, it was $45. Little wonder that earnings are expected to be lower, though expect that to improve for the second quarter.
Materials, another big decliner, is facing very low revenue growth (up only 1.7%), due to pricing pressure.
What are companies likely to tell us about the state of the global economy?
"You'll hear about a slower Europe, but the key is stabilization in China," Raich said. "China got a lot of stimulus — China stocks are up almost 30 percent this year. If you can stop some of that bleeding, that will go a long way toward stopping the declining earnings."