Earnings season takes off today and tomorrow, with America’s big banks the first out of the blocks in this quarterly snapshot of corporate health. By the beginning of November around 90% of the S&P 500 constituents will have updated investors on their results.
The third quarter results season tends to be watched evenly more closely than the other three rounds of earnings announcements because companies often use this set of results to manage expectations about the outlook for the next calendar year.
This year, that process of expectation management is more important than ever because, eight and a half years into the current bull market, stock market valuations have risen to historically high levels. That piles up the pressure on companies to deliver better than expected results. Investors’ tolerance for disappointments will be low this year.
This goes some way to explaining the relatively low expectations for earnings growth in the third quarter. Companies are wise to the impact of missing forecasts so they try to set the bar low enough for them to beat easily.
According to Goldman Sachs, earnings growth is expected to be just 5% in the three months from July to September. Stripping out recovering energy companies’ profits, the average growth rate is even lower - just 3%. That compares with 14% and 11% respectively in the first two quarters of 2017.
Part of the slowdown is a one-off consequence of this year’s particularly damaging hurricane season. The financials sector is also expected to be hit by comparisons with a profitably volatile period after the EU referendum last summer. Trading activity and loan growth have been much more disappointing this year.
Looking further into the future, analysts expect earnings to bounce back, with double digit gains predicted in the fourth quarter and throughout 2018.
That’s the good news. The bad news is that with the US equity market trading at a historically high multiple of expected earnings, companies really do need to deliver.
The re-rating of the market has been the principal driver of the long and profitable bull market since the financial crisis. Now profits growth needs to pick up the baton.
A few things to look out for in the weeks ahead:
In our latest Investment Outlook, we have become increasingly cautious about the equity markets generally and the US stock market in particular.
Earlier this week, Maike Currie and I held our regular webcast to discuss the Outlook and take our customers’ questions on it. If you missed the broadcast you can watch it in catch up here.
High valuations and ongoing pressure on profit margins are the main reasons to be concerned. The earnings season which gathers pace today will be key to whether our caution is justified.
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