From BlackRock: Uncertainty over the sustainability of earnings growth is fueling equity market weakness, reinforcing our call for boosting resilience in equity portfolios. Richard Turnill explains.Equity market performance has been weak so far this earnings season, with market participants more focused on earnings growth sustainability than generally strong third-quarter reports. We believe the uncertainty around future earnings growth has increased and will likely remain high, reinforcing our call for adding resilience to equity portfolios via exposures to quality companies.
Recent equity market weakness is not a reflection of current earnings, in our view. See the divergence between the blue and green lines in the chart above. Rather, we attribute it to the uncertainty surrounding the sustainability of strong earnings in 2019 and beyond amid rising concern about trade conflicts and their impact on global supply chains. The pace of earnings growth so far has slightly moderated relative to the second quarter as expected, but it’s still on track to be very strong year over year, especially in the U.S. Revenue growth has been slower than the robust 10% for the S&P 500 in the second quarter, but consensus estimates point to 7% growth this quarter, well above the long-term average. And estimates for third-quarter earnings-per-share and fourth-quarter sales have drifted higher over the quarter, even as headlines have focused on negative surprises.
What’s ahead for earnings?
Last week’s selloff appears to be a risk-off event, with bond yields falling and defensive stocks outperforming. Our analysis shows a fade in overall market risk positioning not explained by current earnings; even the stocks of many companies beating analysts’ expectations sold off. Market participants look to be increasingly sensitive to the tone of corporate management teams’ forward guidance during earnings calls. A number of companies have talked about the impact on global supply chains of a deteriorating U.S. trade relationship with China. Increased tariffs could prompt some companies to shift supply chains out of China. The costs of such adjustments could be significant, potentially threatening corporate margins in the quarters ahead. Our Systematic Active Equity team has picked up greater market concern around rising labor costs. U.S. midterm election uncertainty may also be adding to the anxiety.
It’s fair to expect a slower pace of earnings and sales growth in 2019, in our view. This partly reflects a higher year-on-year hurdle after the big boost to corporate earnings from U.S. tax cuts. We also see a moderate slowdown as consistent with our view that the global economy is transitioning to the later stages of the economic cycle. Our BlackRock GPS indicator still points to robust global growth over the next year with moderate inflation. This should provide a positive backdrop for corporate earnings. Yet the range of potential outcomes for corporate earnings looks to be widening, just as uncertainty around the growth outlook has risen. The outlook for corporate margins could turn south if trade conflicts escalate in 2019 and pricing pressures build further, potentially hitting earnings.
Our base case is that solid global growth will support corporate earnings, but the risks to this view have increased as geopolitical tensions and less-stimulative fiscal and monetary policies amplify economic uncertainty and investor angst. Against this backdrop, we advocate boosting portfolio resilience via exposures to quality companies, particularly those with strong balance sheets and solid earnings prospects. We find these firms primarily in the U.S. We like the technology and health care sectors in particular.
The iShares S&P 500 Index ETF (IVV) rose $1.76 (+0.65%) in premarket trading Wednesday. Year-to-date, IVV has gained 0.83%.
This article is brought to you courtesy of BlackRock.