Wall Street’s predictions for this quarter’s earnings are shrinking fast. That’s a bellwether for rolling downgrades as the year wears on––and a signal that the market’s current bull run could turn into a bear stampede.
On Friday, FactSet, the data analytics firm that compiles consensus market forecasts, issued a report noting that equity analysts now expect S&P 500 earnings-per-share to drop by 2.2% in the quarter ending March 30, compared with the same period in 2018. That’s a 5.4 point negative swing from the outlook on December 31, when the banks projected EPS gains of 3.2%. For the entire year, Wall Street has cut its estimates from 7.2% to 4.8%. But even those subdued expectations are suspect: The analysts are counting on 9.1% growth in Q4 to compensate for virtually flat profits for the first 9 months. After that, the profit boom is supposed to resume, with EPS jumping 11.4% in 2020––a number that’s actually higher than the forecast at year end.
Wall Street is usually overly, even wildly optimistic in charting the S&P members’ future fortunes, and the numbers almost always drop as the earnings announcements grow closer. But this time, the downward adjustments are coming faster, and in bigger increments, than usual. Look for the trend to continue in the coming months. Smart investors should examine where revenues and margins are going, and do their own reality check before the analysts post the inevitable parade of downgrades. The fundamentals make it virtually impossible for Q4 to bail out 2019, or for profits from the start of 2019 to the end of 2020 to rise the projected 16.7% over the record-setting performance in 2018 (that this year’s forecast of 4.8%, plus the 11.4% projected for 2020).
A pair of stubborn obstacles are thwarting earnings growth––a slowing economy, and a level of profitability that’s reached the limits of economic gravity. For this year, the CBO foresees GDP advancing by 4.8% including inflation, but throttling back in Q4, when Wall Street expects that big jump in EPS that’s supposed to rescue the year, and for 2020, the agency expects a downshift to just 3.9%. In 2018, the S&P 500 companies achieved record margins of around 11%, a level that’s 2 points higher than the average over the past 9 years. So where would margins need to go for the S&P to ring the bell by hitting the 9.1% mark for Q4, and the the total of nearly 17% for 2019 and 2020?
Let’s assume that revenues rise with nominal GDP––in effect, sales constitute national income, so that’s a reasonable scenario. In that case revenues would increase by a total of 9% by the end of 2020. But since profits are projected to wax a lot more, today’s record margins need to rise, by my reckoning, to 11.8%. In a period when labor and interest costs are already eroding super-rich profits, and when sluggish sales curb “operating leverage,” margin expansion achieved through economies of scale, it won’t happen.
The smart bet is that profits will be flat at best in for 2019. Historically, earnings don’t leap from peak to peak. Following periods when they’re unusually high, corporate profits adjust downward towards their long-term average share of revenues and GDP, and right now, they’re an outsized high percentage of both, and overdue for a correction. How about the argument that revenues abroad will grow at lot faster than stateside, so that foreign profits will rise much faster the dollars earned on lackluster domestic sales? Not so. In its February 5 report, FactSet compiled Wall Street’s earnings forecasts for two categories of S&P members, those with over 50% of their sales abroad, and those that reaped over half their revenues in the U.S. For 2019, the survey forecast growth for the U.S.-centric companies of 6.7%, one-seventh higher than the 5.9% analysts expect from the “global” group.
Wall Street wants us to believe that profits bonanza has merely stalled. But suddenly, the banks’ sobering near-term forecasts are telling the real story––that lean times lie ahead.