Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Stocks have continued to inch higher as the market attempts to recover from the near-bear market sell-off. The start of earnings season has helped to buoy stocks thus far despite a significant ratcheting down of estimates heading into the reporting period. How low is the bar for Q4 results right now?
Stovall: Well, the bar has gotten down to an expected 12.1% year-on-year gain for the S&P 500. As of the end of December 2018, the fourth quarter estimate was for a 13.7% gain. As of the end of the third quarter of 2018, the estimate had been for 18.5%. We’re talking about a 600-basis point reduction in earnings. So, it’s really steep.
Also, right now we’re looking at essentially more than half of the sub-industries (six of 11) seeing earnings estimate reductions as compared with what was projected at the end of 2018.
EQ: Since at least last quarter, investors were already looking ahead to 2019 in anticipation of a major earnings slowdown. What topics are you most interested in hearing management teams address in their guidance in the weeks ahead?
Stovall: Obviously, the guidance is most important because everyone is saying that fourth quarter 2018 earnings are already ancient history. What is a bit disconcerting is that fewer than one-third of the sectors in the S&P 500 have seen earnings revisions to the upside for all of 2019. Right now, the estimate is for a gain of 5.6%. The estimate had been 6.5% as of Dec. 31, 2018.
With so many sectors now having estimate reductions, you do sort of wonder why the market continues to be moving to the upside. Maybe it is simply a reflex rally off the near-bear market decline, or possibly investors are looking for catalysts, such as a trade agreement with China, the end of the rate-tightening program, etc., to help push those earnings back up once again.
EQ: In terms 2019, which sectors are expected to face the most challenging environment ahead?
Stovall: I think the biggest question mark goes to Energy. At the end of 2018, Energy was expected to show a 9% gain in earnings. Now, it looks as if Wall Street is projecting a 2% decline for year-on-year earnings, and it’s not because the bar was set so much higher in 2018. Actually, the full-year number is now expected to be slightly lower than where the estimate was at the end of 2018. That’s sort of a headscratcher at this point as to what Wall Street is really looking for.
Also, there are areas that really have only seen very minor, if any, changes to their estimates, such as Industrials and Consumer Discretionary. You sort of wonder why they are exempt from any earnings slashes. So, I would tend to say that maybe there’s more to come when it regards those two cyclical sectors.
EQ: When you look at the estimates for these two groups, relative to the other sectors, they look pretty strong. Is it because the expectation is that they’re poised to do well, or is it just that they haven’t been touched by revisions yet?
Stovall: In the case of Consumer Discretionary, at the end of 2018, they were expected to show a 6.4% gain for the fourth quarter. That estimate is still the same. For full-year 2019, the prior estimate was for a 7.1% gain, which has been revised to 7.0%. So, it’s not much of a change at all.
Ditto for Industrials. Their Q4 number is essentially the same at around 17.5%, and their full-year 2019 estimates still hovers around 10%. So, either the analysts have gotten it right or there are more revisions to come for those two sectors.
EQ: Are there any sectors that could be showing some promising signs of growth, all things considered?
Stovall: Yes, Communication Services, which is the new sector that includes the old Telecom Services—such as AT&T and Verizon—that has been connected with the Media sub-industries from the Consumer Discretionary group as well as the Software and Services group from Technology. That’s expected to show an improvement in earnings projections, not only for the fourth quarter—going from 11.5% expected at the end of 2018 to 12.2% currently—but also for full-year 2019, which was at 4.9%, but is now at 5.3%.
Also, Utilities—believe it or not—I guess because they are expected to take it on the chin in the fourth quarter of 2018, are expected to see a bit of a recovery in 2019, going to a 4.5% expected rise versus the earlier forecast of 2.8%.
EQ: The current government shutdown is now the longest in US history. While the market typically shrugs off these events, economists are projecting a reduction of 0.05 to 0.13 percentage points off quarterly GDP for every week this saga drags on. What kind of implications could that have on investors if this isn’t resolved soon?
Stovall: Typically, government shutdowns have been more headline events than bottom line events. Essentially, the S&P 500 went nowhere from the day the government was shut down until the day the shutdown had ended. Now that we are in the longest shutdown in history, obviously we are in uncharted waters. But again, the question is, “then why is the S&P 500 up 8.5% since through Wednesday?” I think what it implies is the market believes the government will end up resolving its differences before it becomes too big of a problem.
Also, I think investors are again recouping losses from the near-bear market that they suffered in December. Plus, they anticipate something positive from trade negotiations from China, as well as the Fed most likely to be putting their rate-tightening program on hold. So, I think investors again are looking forward and are pretty much looking past the government shutdown.
EQ: Over the course of 2018, as record earnings were reported, stocks went lower. Now with the fundamentals looking softer, stocks are moving higher. Is it strange to you that the market continues to move in the opposite direction of fundamentals?
Stovall: Well, I guess that’s why they say prices lead fundamentals. Initially, I think investors were worried that we were headed for a recession because of the earnings slowdown, the trade tensions with China and what oil prices were telling us. But now oil prices have rebounded a bit and negotiations with China continue to be constructive. So, I think investors are hoping to be pleasantly surprised in 2019 and have probably delayed the prospect of recession until 2020.
Read Next
