Earnings & Earnings Expectations Continue to Decline, Stock Market May Fall Hard
Fact: companies’ earnings and earnings expectations drive the stock market higher or lower. If anyone says otherwise, run away from them.
Sadly, at the moment, earnings are falling, and expectations don’t seem that great. Will this be good for the stock market? Not very likely. Declining earnings and dismal earnings expectations could drag stocks lower.
So, if you own a lot of stocks, it might be a good time to pause, reflect, and focus on capital preservation.
Now, time for some perspective.
What do you think happened to the earnings of S&P 500 companies in the first quarter of 2019? Earnings declined.
In the second quarter, earnings declined again.
We are currently in the midst of the third-quarter earnings season. So far, 40% of the S&P 500 companies have reported their earnings for the quarter. As a whole, they reported a decline of 3.7% year-over-year in their profitability. (Source: “Earnings Insights,” Factset, October 25, 2019.)
Going into the third-quarter earnings season, analysts were expecting S&P 500 companies to report an earnings decline of four percent.
The even more troubling part: companies are already issuing warnings about their fourth-quarter earnings. So far, 26 out of 38 S&P 500 companies have issued a negative guidance about their earnings, while just 12 have issued a positive guidance.
How are the expectations for the fourth quarter of 2019? Gruesome to say the least.
At the time of this writing, Wall Street analysts are expecting fourth-quarter earnings to grow by 0.7% year-over-year.
But keep in mind, the fourth quarter just began. In early 2019, these same analysts were expecting fourth-quarter earnings to grow by double-digits. So it wouldn’t be surprising to see their estimates get worse.
Expectations Could Get Worse
Digging in a little bit deeper…
You shouldn’t overlook risks at the moment. They could really impact the earnings and expectations going forward.
For example, the global economy is slowing down. There is a ton of evidence of this happening. It could hurt earnings.
So far for the third quarter of 2019, S&P 500 companies that generate more than 50% of their revenue outside of the U.S. have reported a decline of 2.1% in revenue and a decline of 9.1% in their earnings.
The U.S. economy isn’t safe either. Look at any economic data and it’s very likely that, underneath the surface, things are getting worse.
The slowing U.S. economy will also have dire consequences on the earnings of companies.
Stock Market Crash Could Become Likely
Dear reader, in the long run, fundamentals matter a lot. The stock market could run on irrationality for a while, but not forever. It comes back to fundamentals.
Earnings declining and expectations tanking are warning signs that shouldn’t be taken lightly.
If earnings continue to decline and expectations tumble further, don’t anticipate anything great from the stock market. Don’t expect stellar returns like the ones we saw in 2016 and 2017. In fact, a stock market crash could become a likely scenario the longer this goes on.