Let’s say, for argument’s sake, you manage to extricate yourself from trade worries, domestic political turmoil, geopolitical chaos and, of course, the daily onslaught of negative economic data.
In that hypothetical, you’d be free to focus on what should matter for equities – namely, corporate profits. Of course, corporate bottom lines are inextricably bound up with trade, geopolitics and macro fundamentals, but amid the cacophony, it’s easy to forget that at the end of the day, investing in stocks is about staking your claim to the assumed long-run prosperity of corporations, not necessarily about making a call on impeachment or next month’s ISM or debating the relative merits of this or that Mideast strategy.
There’s just one problem. As noted over the weekend, Q3 2019 is set to be the first quarter of negative EPS growth in more than three years in the US. Ex-Energy, the third quarter is expected to see the first YoY decline in earnings since Q2 2009.
In 2018, you could always point to blockbuster bottom line growth and the resiliency of the US economy as a rationale for remaining bullish despite a tumultuous political environment, economic deceleration abroad and a hawkish Fed.
Fast forward to 2019, and the US economy has decelerated along with corporate profits, as the fiscal impulse wanes.
In a Monday note, SocGen’s Andrew Lapthorne strikes a characteristically cautious tone in warning that “the recessionary message is getting ever louder”.
After citing the veritable collapse in global bond yields and persistent underperformance of economically-sensitive sectors and markets (September’s “anomalous” rotation flirtation notwithstanding), Lapthorne notes that “globally, analyst sentiment has slumped, typical of a negative EPS growth outlook”.
But, with falling bond yields mechanically supporting equities, do earnings even matter anymore?
“Well, that’s a question we often ask ourselves”, Lapthorne says, waxing colloquial, on the way to saying that the answer still “seems to be a resounding Yes”.
In the visual below, SocGen “decile ranks changes to company 12m forward EPS targets against the coincident performance of stocks over the same period”.
Clearly, that suggests earnings and prices are still correlated.
“So earnings do still matter”, Lapthorne insists. “And there’s the problem, as earnings are now going down, not up.