On a day when the broader market failed to take comfort in a key earnings beat that by many accounts should have catalyzed another leg higher for tech on the way to restoring faith in Growth and Momentum after last week’s “wrong-way” rotation and concurrent systematic unwind, it’s probably worth reminding everybody that when it comes to earnings, Q3 is as good as it’s going to get for quite a while.
This year has been interesting from a fundamental perspective as it marked a rare case when market participants knew, with something that approximated certainty, that corporate bottom lines would get a boost and the U.S. equity market would enjoy downside protection in the form of a reinvigorated corporate bid.
Both of those tailwinds came courtesy of Trump’s fiscal policies, but the quandary for investors was that as certain as everyone was about the near-term positives, it was (and still is) equally certain that the sugar high will wane, leading to a sharp drop off in earnings growth and fewer buybacks.
That’s the nature of stimulus. Inherent in the term “stimulus” is the idea of a fleeting jolt; an adrenaline shot, if you will. Of course the architects of that stimulus will always claim that the policies are designed to engineer long-term prosperity and everyone associated with the effort will swear up and down that the short-term gains are “sustainable”, but they never are. Again, that’s the nature of “stimulus”.
So here we are in Q3 and again, what you want to keep in mind if the market refuses to respond to strong profit growth, is that this is it – “peak earnings”, to quote a new note from Barclays.
“We expect the strong earnings growth [in Q3] to be driven by margin expansion due to the cut in corporate taxes, stronger consumption growth due to a cut in personal taxes, effects of fiscal stimulus, and a rebound from the 2015-2016 mini industrial recession”, the bank writes, in a note dated Wednesday, before warning that going forward, their base case is “that of a sharp earnings slowdown after the current quarter since most of the drivers this year were one-time in nature. ” Here’s a simple chart which tells you everything you need to know:
There isn’t much that’s complicated about this, but it bears (get it?) mentioning because the market is inundated on a weekly basis with economic agitprop from Larry Kudlow, who has become Trump’s go-to guy when it comes to (loudly) insisting that reality isn’t reality.
This isn’t so much an effort to malign the policies themselves (if that’s what you want, you can read to your heart’s content here and here), as much as it is a simple heads up: When it comes to bottom line growth, it ain’t gonna get any better from here. Earnings growth is going to naturally decelerate and what you should note is that tariff effects could well make the slowdown materially worse.
“For the S&P 500 index we expect earnings growth to slow below 10% during 2019H1 [and] this does not include the effect of tariffs on the US-China trade which could further pressure earnings”, Barclays goes on to say, in the same cited note.
In the near-term (and this is a bit of bonus info that may or may not be useful), BNP was out Wednesday reiterating the notion that last week’s technical correction is likely to prove short-lived.
“The recent spike in equity vol is very reminiscent of some of the other short lived technically driven periods of de-risking we have seen in the current bull market [and] fundamentally little has changed”, the bank writes, adding that “if anything, the strong macro data that seemed to drive bond yields higher and trigger the equity market sell-off is actually constructive for equities.”
On BNP’s Macro/Vol model, equity volatility “should” be expected to normalize and the bank says that assuming earnings growth continues to be robust, they “would expect the SPX to consolidate above the 200d MA (2766) and for the VIX to trend lower.”
Fingers crossed, I suppose.