Wall Street forecasts to face reality check
Wall Street’s eternally optimistic forecasters are expecting corporate profit growth to surge by the middle of next year — views that are about to collide with reality as hundreds of companies report financial results and update investors on their prospects.
American companies go through this ritual every three months: sharing financial statements and holding conference calls in which they sometimes offer their expectations for future quarters, what Wall Street calls “guidance.” For this quarter, it begins with reports today from several big banks.
In between these reports, executives continue to issue guidance, trying to nudge expectations higher or lower so official results don’t jolt investors.
Lately, they’ve been doing less of the in-between nudging, and that could make this round of earnings reports more important than usual.
“Companies are starting to do what they do when there is rampant uncertainty, which is just stop issuing guidance,” said Savita Subramanian, head of United States equity strategy at Bank of America Merrill Lynch. “Companies just basically go dark.”
During the three months that ended in September, companies in the S&P 500 offered the fewest updates — positive or negative — to investors since 2000, according to the bank’s analysts.
The “rampant uncertainty” that Subramanian referred to flows from many sources: signs that the economy and job growth are slowing, evidence that the manufacturing sector may already be in a recession, and the trade war’s toll on China, Japan and Germany.
Plus, politics and the 2020 presidential election were always going to be a distraction, but the impeachment investigation has made it harder to know where policy will go.
On Friday, President Donald Trump said the United States and China had reached an interim deal to avert a planned tariff increase. But the agreement was spoken and would take several weeks to write, doing little to remove the uncertainty surrounding the economic battle between Beijing and Washington.
Regardless of the companies’ reasons, the relative silence since their last reports means stock investors may be in for a lot of bad news all at once.
Then there’s the matter of the habitually overenthusiastic Wall Street analysts who rate stocks and try to predict where they’re heading. Stock prices hinge on expectations — not on what just happened — and the predictions look increasingly divorced from reality.
Right now, the collective forecast is that profits at S&P 500 companies will jump more than 10 percent in 2020, a view that defies expectations for the economy to slow further.
“It doesn’t look likely,” said Ralph Davidson, chief global equity strategist at BTG Pactual, a Brazilian investment bank, of the profit forecast. “We expect guidance to be coming down.”
It’s not that double-digit profit growth is unprecedented. In 2018, earnings jumped 22 percent after a sharp cut in corporate taxes. But it’s becoming clear that last year’s surge was a one-time jolt.
The current year offers an example of what may happen if it dawns on analysts that they’re being too rosy. Last October, they were forecasting that profits would grow about 10 percent in 2019. Those targets came down fast at the end of the year because of sudden worry that the trade war and rising interest rates might tip the economy into a recession.
As the year progressed, and companies reported results, the analysts cut the forecast down, again and again.
Now, they expect that profits will have grown just under 2 percent once the year is done. For the third quarter, which ended in September, analysts expect S&P 500 companies to report that their profits fell 3 percent.
Lower profits aren’t necessarily bad news for the economy. One reason corporate earnings have been pinched is that wages have been rising. That reflects the strong job market and helps support consumer spending, which is the bedrock for economic growth in the United States.
But eventually investors will have to turn their attention back to the fundamental question of whether profits are going to keep growing, and how fast. And that could make the next few weeks rocky.“I think we’re going to see a wave of negative guidance on next year’s earnings,” said Subramanian of Bank of America. “And that might not be great for the market.”