Where have all the earnings gone?

26 Feb 2019

US companies’ earnings growth following the Q4 2018 sell-off could slow to the point of an ‘earnings recession’. But – outside energy and tech – the outlook may not be as bleak as it first appears.

  •  Still reasons to be cautious, with earnings surprises below average
  •  Energy and tech account for the bulk of the drop in earnings estimates
  •  Forward earnings revisions for the rest of the index have more than recovered the downgrades from last quarter.

A deceleration in S&P 500 earnings growth has been on the cards for several months. After growth rates above 20% in 2018 thanks to the Trump tax cuts, earnings per share (EPS) expansion was expected to revert to its pre-tax cut rate of around 10%.

As of September 2018, year-on-year EPS growth was forecast to be nearly 12% for the fourth quarter of 2018, a still reasonably robust 6% for the first quarter of 2019, and nearly 8% by the end of the year. The significant negative earnings revisions we’ve seen following the market’s selloff in the fourth quarter of 2018 have changed that outlook.

Instead of 12% earnings growth for fourth quarter 2018, it’s likely to be under 8%. And rather than 6% in the upcoming quarter, an “earnings recession” looms, with EPS forecasted to fall by over 3%. Forecasts for the final quarter of 2019 are little changed, but that’s only because estimates have been revised down for both periods.

Exhibit 1: Going down – year-on-year forecasted EPS growth rates


There are other reasons to be cautious about the outlook. Even though earnings growth this season has still been good, earnings surprises were below average (that is to say, companies hardly beat already lowered expectations). And guidance about the outlook for the rest of the year was particularly poor.


Exhibit 2: Positive corporate guidance on earnings as a percent of total


A few factors, however, show why the outlook may not be as bleak as it first appears. While most sectors have indeed seen estimates lowered, energy and technology (in particular Apple) account for the bulk of declines:

  • The 40% fall in oil prices that began in June 2018 was inevitably going to be reflected in profit forecasts but the 30% rebound since the lows in late December mean estimates should at least partly recover.
  • Apple’s announcement in December of disappointing iPhone sales does not seem to have signalled a broad reassessment of the earnings outlook for the tech sector; estimates for other companies have fallen, too, but in line with the market as a whole.


Exhibit 3: Sector contribution to change in first quarter 2019 EPS estimates since September 2018


If you exclude Energy and Tech from the EPS calculation, than earnings growth in the first quarter is likely to be flat (compared to an expectation of 4.8% growth four months ago), and should improve from here.  In fact, forward earnings revisions for the rest of the index have more than recovered the downgrades from last quarter.

Exhibit 4: S&P 500 next-twelve-month earnings estimate


The forward price to earnings ratio for the S&P 500 index is a bit above average –  16.4 times versus a long-run average of 15.1 times – but if earnings do rise at the rate forecast, then the market should still be able to generate mid to high single digit returns in 2019.