In­ves­tors Fret Pro­fits Are Pea­king

L'Opinion - - The Wall Street Journal - Mi­chael Wurs­thorn

The post­cri­sis boom in U.S. cor­po­rate pro­fits may be near its peak, in­ves­tors and exe­cu­tives say, a po­ten­tial threat to a ni­neyear ral­ly that has ta­ken the Dow Jones In­dus­trial Ave­rage up more than three­fold.

With more than half of S&P 500 firms ha­ving re­por­ted re­sults, third-quar­ter ear­nings have ri­sen 24 % from the same per­iod a year ear­lier, dri­ven by strong gains at firms from re­tail and web-ser­vices giant Ama­zon.com Inc. to ma­nu­fac­tu­rers Ge­ne­ral Mo­tors Co. and Boeing Co. That com­pares with 25 % in­creases in each of the past two quar­ters and the 20 % gain that Wall Street ana­lysts were fo­re­cas­ting, ac­cor­ding to FactSet. Sur­ging ear­nings have been the ma­jor dri­ver of the Dow in­dus­trials’ run this year to 15 re­cords. Last year’s cor­po­rate tax cut su­per­char­ged pro­fits, ea­sing stret­ched va­lua­tions and fue­ling an in­tense ral­ly in some of the fas­test-gro­wing, most high­ly va­lued com­pa­nies.

But exe­cu­tives and in­ves­tors are now saying they be­lieve the ear­nings bo­nan­za is at an end. Ana­lysts are fo­re­cas­ting 6 % pro­fit growth in each of the first two quar­ters of 2019, as the im­pact of the tax cut dwindles. That is down from the 7 % ana­lysts had been fo­re­cas­ting in ear­ly Oc­to­ber.

The ear­nings slow­down stands to add to concerns swir­ling around U.S. stocks in the wake of an Oc­to­ber rout that rat­tled ma­ny in­ves­tors and sent the S&P 500 to its dee­pest month­ly de­cline since 2011. While ana­lysts and port­fo­lio ma­na­gers re­main lar­ge­ly bul­lish, conten­ding that stocks on­ly got more at­trac­tive re­la­tive to other in­vest­ments in the wake of last month’s sel­loff, ma­ny are star­ting to pre­pare for a more un­pre­dic­table per­iod in both the U.S. and Eu­rope, in which they won’t be able to bank on wind­fall pro­fits. “This is a ve­ry clas­sic end to the bu­si­ness cycle to me,” said Dean Te­ne­rel­li, a T. Rowe Price port­fo­lio ma­na­ger in Lon­don. “Ex­pec­ta­tions are ve­ry high for com­pa­nies, va­lua­tions are ve­ry high for com­pa­nies and even­tual­ly things start to slow, along with the eco­no­my and ear­nings mo­men­tum.”

Mr. Te­ne­rel­li’s fund re­cent­ly bought shares of some in­dus­trial com­pa­nies, ta­king ad­van­tage of the lo­wer va­lua­tions of what he consi­de­red to be over­sold stocks that had strong ear­nings and stable pro­fit mar­gins.

While ear­nings growth over time tends to be the stron­gest dri­ver of stock-price gains, ana­lysts say, it is clear other fac­tors can com­pen­sate in sup­por­ting share prices in the near term. Cor­po­rate buy­backs will li­ke­ly pick up in co­ming months, in­ves­tors say, and fo­rei­gn buyers who have been lar­ge­ly ab­sent la­te­ly could pour more mo­ney in­to the U.S.

Ac­cor­din­gly, Wall Street ex­pects stocks to rise, even if hal­tin­gly. Bank of Ame­ri­ca Mer­rill Lynch fo­re­casts the S&P 500 will rise to 3000 by the end of the year from 2723 Fri­day, im­plying a gain of 10 %. That tar­get is 2850 at Gold­man Sachs Group Inc., im­plying a gain of less than 5 %, while Mor­gan Stan­ley fo­re­casts an S&P 500 rea­ding of 2750 by mid-2019, up just 1 %.

But the threat to the mar­ket has been clear in this ear­nings sea­son. The dol­lar’s rise this year has hit mul­ti­na­tio­nal com­pa­nies that convert over­seas sales back in­to U.S. dol­lars. Com­pa­nies from Apple Inc. to Kel­logg Co. have said in recent ear­nings re­ports that the dol­lar’s 4 % rise this year has hit pro­fit and sales in coun­tries like Tur­key, Bra­zil and In­dia.

Even the world’s most va­luable com­pa­ny is sho­wing si­gns of slo­wing down. Apple Inc. said Thurs­day that re­ve­nue for the fi­nal th­ree-month per­iod of the year would come in be­low ana­lysts’ es­ti­mates, with the stron­ger dol­lar pres­su­ring re­sults in emer­ging mar­kets. “These are mar­kets where cur­ren­cies have wea­ke­ned over the recent per­iod. In some cases, that re­sul­ted in us rai­sing prices and those mar­kets are not gro­wing the way we would like to see,” Chief Exe­cu­tive Tim Cook said Thurs­day on an ear­nings call with ana­lysts. Drug­ma­ker Pfi­zer Inc. last week nar­ro­wed its ful­lyear re­ve­nue and pro­fit tar­gets, saying that the rol­loff of cer­tain pa­tents and pri­cing chal­lenges will crimp sales. Scotch tape and in­dus­trial adhe­sives ma­ker 3M Co. al­so lo­we­red its ear­nings fo­re­cast for the year and re­por­ted slo­wer sales growth in the third quar­ter, ci­ting cur­ren­cy troubles. Ad­ding to concerns about the fu­ture re­turns for U.S. stocks: the conti­nuing trade spat bet­ween the U.S. and Chi­na, which threa­tens a new source of hi­gher prices and nar­ro­wing de­mand for some com­pa­nies. The out­look for Eu­ro­pean stocks is si­mi­lar. Com­pa­nies in the Stoxx Eu­rope 600 are on pace to ex­pand pro­fits by 14 % from a year ear­lier, the hi­ghest growth rate since the end of the year, ac­cor­ding to I/B/E/S da­ta from Re­fi­ni­tiv. But ana­lysts pro­ject that pro­fits pea­ked in the third quar­ter, ex­pec­ting ear­nings across Eu­ro­pean com­pa­nies to come in lo­wer through 2019.

SEB SA, a French hou­se­hol­dap­pliance ma­ker be­hind brands like Te­fal, was among com­pa­nies that cut re­ve­nue gui­dance, bla­ming fo­rei­gn ex­change and ri­sing ma­te­rial costs on crea­ting a “dif­fi­cult en­vi­ron­ment.” Shares have tum­bled 15 % this quar­ter.

“In­ves­tors are re­pri­cing as­sets across the mar­ket,” said JJ Ki­na­han, chief mar­ket stra­te­gist at TD Ame­ri­trade of bro­ke­rage TD Ame­ri­trade Inc. “This is going to conti­nue through the end of the year.”

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