Earnings

Wall Street faces a tough earnings season: 'Caution probably makes sense right now'

Key Points
  • S&P 500 companies collectively are expected to show a 4.6% earnings decline from the same period a year ago.
  • There's not much optimism for outlooks, as corporate America faces many of the same problems ahead as it did in the third quarter.
  • The season has gotten off to a good start, with 21 of 23 companies beating profit estimates.
  • Earnings season kicks into high gear this week, with 52 companies set to report, including all the major Wall Street banks.

Companies head into the third-quarter earnings reporting period with trouble behind, more hazards ahead and a muddied road map to guide the journey.

As the season kicks into gear this week, S&P 500 firms are expected to report a 4.6% earnings decline over the same period a year ago, according to FactSet. If the period ends up with a negative number, that will make three quarters in a row, the first time that's happened in three years.

Investors never seem to focus on what's in the rearview mirror as much as they do the outlook for what's on the horizon.

In this case, though, they're likely to see the same thing: Profits weighed down by tariffs, economic weakness and geopolitical tumult that seems unlikely to go away anytime soon, despite the recent good news that the U.S. and China have reached at least the first phase of a trade agreement.

"I don't think we flipped the switch last weekend," Art Hogan, chief market strategist at National Holdings, said in regard to the trade news. "My guess is the tone's going to be as cautious as it's been. But caution probably makes sense right now."

There's actually been good news in the nascent earnings season as 21 of 23 companies that have reported thus far have beaten Wall Street estimates on bottom-line profit, while 12 of those firms have exceeded revenue forecasts. Bank of America Merrill Lynch says there's an 82% correlation between how early reporters do compared to how the rest of the season goes.

Still, the firm, like a number of others on the Street, says expectations for the future need to be tempered.

"We think consensus is too high for 4Q and 2020, and lower guidance vs consensus could be a key risk for stocks this earnings season," Savita Subramanian, equity and quant strategist at BofAML, told clients in a recent note. "Companies' lack of visibility into next year, with just three months left in the year, will likely build more uncertainty among investors and likely result in lower 2020 estimates, in our view."

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Investors will get a sharper picture of what's happening this week, when 52 S&P 500 companies report. Focus will be on big Wall Street banks as J.P. Morgan Chase, Citigroup, Goldman Sachs and Wells Fargo all report Tuesday. BofA is up Wednesday while Morgan Stanley reports Thursday. 

The banks face a challenging environment as well, with the Federal Reserve in interest rate cutting mode and the yield curve remaining inverted. Financials as a sector are projected to see a 2.6% earnings decline.

'Whistling past the graveyard'

Company analyst calls among the early reporters has yielded a mixed bag of sentiment.

FedEx rocked the market briefly in mid-September when it missed projections for its fiscal first quarter and warned about economic conditions.

"I watch the business press every day and I have to tell you, I think there's a lot of whistling past the graveyard about the U.S. consumer and the United States economy versus what's going on globally," CEO Fred Smith told analysts. "We're just reporting what's going on and reacting to these macroeconomic things."

Optimists, on the other hand, point to Fastenal.

The industrial construction supplies manufacturer blew away Wall Street with blockbuster earnings Friday that defied worries over a hit to industrials from the trade war and global economic downturn. The sector is projected to report flat earnings, but Fastenal provided hope that things may not be so bleak, particularly regarding tariffs.

"We're pleased with the efforts ... to mitigate the effects of tariffs and inflation during this period," chief financial officer Holden Lewis told analysts, adding that the company sees no "incremental drag" for either the third or fourth quarters due to tariff impacts.

Benefiting from pessimism

In fact, of the 10 companies thus far who have cited tariff impact, only five have talked about the duties in a negative sense, according to FactSet.

"We are working with suppliers daily," Costco CFO Richard Galanti said on the big-box retailer's conference call. "We've gone to pretty much every supplier on every item to see what we can do to both reduce costs and figure out how to do that."

Officials from Nike and AutoZone expressed similar hopes of being able to navigate the tariff minefield, though AutoZone CEO William Rhodes did say customers are likely to start feeling the pinch of higher prices ahead.

In all, just four sectors are projected to show a profit while six are seen as negative.

Such tepid expectations could provide a lift to a market that in recent quarters has been penalizing misses more than it has been recording beats when it comes to earnings vs. estimates. 

"Our expectations are that with consensus earnings forecasts having been cut substantially ahead of Q3 earnings season chances are there'll once again be enough earnings surprises to the upside to produce an earnings season that disappoints considerably less than was expected initially," John Stoltzfus, chief investment strategist at Oppenheimer, said in a note. "This has happened numerous times this cycle with chances for a repeat performance in this quarterly earnings season."

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