Multinational companies are getting clobbered by Trump's tariffs

Key Points
  • Earnings haven't been as bad as feared in the second quarter, but that's not been true for multinationals.
  • Companies that generate a majority of revenue overseas have seen a 13.6% drop in earnings.
  • Their more domestically focused counterparts have seen profits increase 3.2%.
  • Analyst Nick Colas says the setup is not necessarily a bad one for the stock market.

While corporate earnings so far have been a bit better than feared, that's not been the case for companies that do the majority of their business overseas and are more susceptible to the tariff battle between the U.S. and China.

Those companies have seen a stunning 13.6% drop in profits, compared with the 3.2% growth seen for companies that generate more than 50% of their sales inside the U.S., according to FactSet. That picture has grown steadily worse — prior to the start of second-quarter earnings season, the multinational group was projected to see a 9.3% decline.

Overall, S&P 500 companies are expected to see a 2.6% drop from a year ago, FactSet estimates, using earnings already reported as well as projections for those yet to report. Through last week, 44% of the index's companies had reported earnings, with 77% beating Wall Street estimates.

Matrix's Katz: Companies are warning about trade with China, and that's slowing the global economy
Matrix's Katz: Companies are warning about trade with China, and that's slowing the global economy

However, the news has been mostly rough for multinationals, which are trying to cope with the tit-for-tat tariffs happening between the U.S. and China for more than a year.

The U.S. has slapped tariffs on $250 billion worth of Chinese imports and is threatening to levy duties against the remaining $300 billion or so of goods that come in. Delegations for both sides are meeting this week in Shanghai, though expectations are low for a major breakthrough.

In addition to the toll taken on the bottom line, top-line sales are hurting. Revenue for companies that do more of their business abroad is down 2.4%, compared with a 6.4% gain for their more domestically focused counterparts.

The results increase the probability that corporate America is in the midst of an earnings recession. The first quarter saw a decline of 0.3%, and early projections for Q3 see a 1.9% drop, according to FactSet estimates.

Companies have been complaining about tariffs while reporting earnings. About one-third of all executives on conference calls have cited the issue as a potential headwind.

Intel, Sony and O'Reilly Automotive are among companies that recently have cited tariff impacts. 

Market implications

Earnings growth has been worst in the materials sector, which is down 18.5%. Industrials are off 12.2%, while energy is down 9.8% and information technology has seen an 8.2% drop.

More specifically, FactSet senior analyst John Butters pointed to industrials and tech as the largest contributors to the multinationals' decline in earnings, while materials and energy were the biggest drains on revenue. Tech, materials and energy respectively rank first, second and fourth in terms of the highest international revenue exposures.

Tariffs along with Federal Reserve interest rate policy are "fulcrum issues for those lofty 2020 Street earnings expectations," Nick Colas, co-founder of DataTrek Research, said in a note this week. FactSet is projecting a strong rebound next year, with the first quarter of 2020 expected to see earnings up 9.2% and revenue growing 5.9%, while the second quarter is tracking at 12.6% and 6.6% respectively.

"That numbers here are too high is certain. But getting a trade agreement and a weaker greenback at least holds out the possibility that S&P earnings growth will reaccelerate," Colas wrote. "Otherwise, it seems clear 2020 will look like 2019."

However, he pointed out that a boring time for earnings doesn't necessarily mean a bad time for stocks.

During 2014-2016, a time that included an earnings recession, stocks rose 28% as Treasury yields plunged. Rates are supposed to remain low, with the Fed likely to approve a cut at this week's policy meeting.

"In a declining interest rate environment flat earnings are good enough to keep stocks moving higher," Colas said. "Yes, earnings growth could be better. Yes, it would be nice if we didn't need to rely on global central banks to see rising stock prices. But this is the world we have, so we'll play the hand we're dealt."