Investors Fret Profits Are Peaking
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.”