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The third-quarter earnings season kicked off in earnest this week, but going-in expectations were for a lackluster performance. According to one analyst interviewed this week on Bloomberg Radio, the lack of clarity across many geopolitical issues is a major factor impacting the willingness for corporations to invest in their businesses, and, “One thing is certain—CEOs don’t like uncertainty.”

CNBC reported,

“Earnings for the S&P 500 are expected to decline by 3.1% for the third quarter. … ‘The story of are we going to be negative, or are we not going to be negative, is going to be in focus,” said Patrick Palfrey, senior equity strategist at Credit Suisse. Palfrey said margins are being pinched in several areas, including energy, with the decline in oil prices. … ‘We are of the view that companies will likely devote a significant portion of their time talking about the impact of trade tariffs,’ Palfrey said. ‘The goal is to ascertain just how much the decline in earnings is coming from those pressures.’”
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Data analytics firm FactSet has a slightly more negative outlook for Q3 S&P 500 earnings, providing the following outlook on October 11:

“Earnings Growth: For Q3 2019, the estimated earnings decline for the S&P 500 is -4.6%. If -4.6% is the actual decline for the quarter, it will mark the first time the index has reported three straight quarters of year-over-year earnings declines since Q4 2015 through Q2 2016.

“Earnings Revisions: On June 30, the estimated earnings decline for Q3 2019 was -0.6%. All eleven sectors have lower growth rates today (compared to June 30) due to downward revisions to EPS estimates.

“Earnings Guidance: For Q3 2019, 83 S&P 500 companies have issued negative EPS guidance and 30 S&P 500 companies have issued positive EPS guidance.

“Valuation: The forward 12-month P/E ratio for the S&P 500 is 16.6. This P/E ratio is equal to the 5-year average (16.6) but above the 10-year average (14.8).

“Earnings Scorecard: For Q3 2019 (with 23 of the companies in the S&P 500 reporting actual results), 21 S&P 500 companies have reported a positive EPS surprise and 12 S&P 500 companies have reported a positive revenue surprise.

“Revenue Growth: The estimated (year-over-year) revenue growth rate for Q3 2019 is 2.7%, which is below the 5-year average revenue growth rate of 3.5%. If 2.7% is the actual growth rate for the quarter, it will mark the lowest revenue growth rate for the index since Q3 2016 (also 2.7%).”

FIGURE 1: S&P 500 EARNINGS GROWTH/DECLINE BY SECTOR (Q3 2019 EST.)

Source: FactSet

FIGURE 2: S&P 500 REVENUE GROWTH/DECLINE BY SECTOR (Q3 2019 EST.)

Source: FactSet

Despite the current earnings outlook for Q3 2019, FactSet has some more positive estimates moving forward:

“Analysts see low single-digit earnings growth in the fourth quarter followed by high single-digit earnings growth for both Q1 2020 and Q2 2020. For Q4 2019, analysts are projecting earnings growth of 2.3% and revenue growth of 3.5%. … For calendar year 2020, analysts are projecting earnings growth of 10.6% and revenue growth of 5.6%.”

This improved earnings picture has led to a “bottom-up” analyst forecast for a rally in the S&P 500 over the next 12 months, says FactSet:

“The value of the S&P 500 has increased by 17.2% since the start of the year. Where do industry analysts believe the price of the index will go from here?

“Industry analysts in aggregate predict the S&P 500 will see a 13.0% increase in price over the next twelve months. This percentage is based on the difference between the bottom-up target price and the closing price for the index as of yesterday (October 10). The bottom-up target price is calculated by aggregating the median target price estimates (based on company-level estimates submitted by industry analysts) for all the companies in the index. On October 10, the bottom-up target price for the S&P 500 was 3321.32, which was 13.0% above the closing price of 2938.13.”

However, FactSet also notes, “Industry analysts have typically overestimated the future closing price of the S&P 500. … Industry analysts have overestimated the price of the index by 2.8% on average over the past 5 years (using month-end values), by 2.2% on average over the past 10 years, and by 9.9% on average over the past 15 years.”
FIGURE 3: S&P 500—BOTTOM-UP TARGET PRICE

Source: FactSet

A 12-month increase of 13% in the S&P 500 would be impressive, and it would certainly break with the current trend of a range-bound market. As Figure 4 from Bespoke Investment Group shows, “U.S. equities have collectively done a whole lot of nothing over the last 18 months, and if you thought policy in Washington was at a standstill, it has nothing on the stock market. Despite some big short-term moves, the S&P 500 is currently at the same levels it was at last month, three months ago, six months ago, and one year ago.”

Bespoke adds,

“After Friday’s rally, the S&P 500 is less than 2% from all-time highs, and that comes amid a backdrop where economic data this week was weak on both an absolute basis and relative to expectations. Not only that, but earnings season kicks off next week [week of Oct. 14], and negative analyst revisions have been outpacing positive revisions by a factor of 2-1. While neither of these trends are positive, they are both predominantly a result of the uncertainty behind the ongoing trade conflict between the US and China. Things may be bad now, but if the US and China can actually meaningfully deescalate and move in the direction of friendlier terms of trade, all will be forgiven as the markets will anticipate an easing of the headwinds to earnings and the economy.”
FIGURE 4: S&P 500 TREND (LAST 12 MONTHS)

Source: Bespoke Investment Group

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