NEW YORK, NY – APRIL 24: Traders and financial professionals work on the floor of the New York Stock Exchange (NYSE) at the opening bell, April 24, 2019 in New York City. U.S. stocks started the trading day mixed, following Tuesday’s closing record highs for the S&P 500 and Nasdaq.
Drew Angerer | Getty Images News | Getty Images
Are you ready for the second half of the year? The bulls are. They already have a narrative to keep stocks up, and push them higher.
First, address trade and tariffs. The hope is that the Trump-Xi meeting this weekend will “reset” relations, the existing tariffs will remain in place while the trade talks continue, but that no new tariffs will be put on.
If that is the case, investor interest will immediately turn to earnings.
Here’s the good news:
- No earnings recession is expected this year (consecutive declines in earnings growth), nor is one projected for 2020.
- Buybacks continue at a strong pace and are providing support to earnings and stock prices, particularly in technology.
Here’s the bad news: Earnings estimates are essentially “flattish” for 2019 compared to 2018. This puts stock investors in a difficult position because it’s hard to justify equities at a record high when there is very little earnings growth expected.
Here’s the current quarterly estimates for earnings growth in the S&P 500:
S&P 500 earnings: 2019
- Q1: up 1.6%
- Q2 (est.): up 0.3%
- Q3 (est.): up 0.9%
- Q4 (est.): up 7.3%
Put it all together, and we are looking at 2019 earnings growth of roughly 2%, which is largely based on expectations of a fourth quarter rebound, so it’s fair to call 2019 “flattish.”
This leaves us with a “forward” earnings multiple of about 17. That’s well above the historic average of 15 to 16.
“It’s tough to justify a high multiple when the global economy is slowing down,” UBS’ Art Cashin told me. “Flattish earnings may not be good enough.”
Why are earnings flattish? The global slowdown and particularly tariff/trade wars have had an impact, particularly in the technology sector. Tech earnings have been trending down all year and are only expected to modestly recover in the fourth quarter:
S&P 500: Technology earnings 2019
- Q1: down 1.1%
- Q2 (est.): down 7.9%
- Q3 (est.): down 6.3%
- Q4 (est.): down 4.1%
Little wonder that bulls are counting on a successful outcome to the China trade talks to turn around earnings.
Counting on the Fed
Bulls are counting on another force to juice those “flattish” earnings: the Federal Reserve.
“The third and fourth quarter are relying on Fed rate cuts, and if we get that there will be a re-acceleration in earnings growth — that’s what the markets are betting on,” Nick Raich, who analyzes earnings at the Earnings Scout, told me.
To support his thesis, Raich pointed to the earnings activity in June. Just the prospects of rate cuts in June improved the gloomy outlook that prevailed in May. “Earning expectations were falling in May, and as soon as the Fed signaled it was likely going to cut rates the decline in earnings estimates slowed down dramatically,” he said.
Bottom line: A lot has to go right to keep the markets — and earnings — up in 2019, but Raich represents the consensus bullish position: “The Fed is going to backstop the market.”