Earnings Slowdown May Hit ETFs

It’s that time of year again. Over the next few weeks, companies across the country will be updating shareholders on the state of their businesses.

Earnings reports for the fourth quarter and full-year 2018 have already started to trickle out from the big banks, but nearly 91% of companies in the S&P 500 have yet to report, according to FactSet analyst John Butters. The deluge begins next week, when 59 corporations will announce earnings and give investors their latest outlook for the year ahead.

With much uncertainty hanging over the markets in 2019, these earnings reports and accompanying guidance will be critical in determining where stocks go from here.

Earnings Slowdown

Ahead of the earnings reports, analysts have been furiously cutting their expectations for profit growth in 2019. From a likely increase of 20.1% in 2018 (the final figures won’t be in until the fourth-quarter earnings season is over), profit growth may dip to 6.9% in 2019, according to a compilation of analyst estimates from FactSet.

Profit growth might start the year even slower than that. Analysts currently peg first-quarter 2019 earnings to increase by only 1.8%. Growth is then forecast to accelerate to 2.9% in the second quarter; 3.6% in the third quarter; and 11.8% in the fourth quarter.

Some analysts, like Mike Wilson of Morgan Stanley, believe earnings growth could slow even further— into negative territory. Wilson sees the chance of an earnings recession, where profit growth turns negative for two-consecutive quarters.

In contrast to the tax cuts that juiced 2018 profits, companies are grappling with a global economic slowdown, higher interest rates and trade uncertainty—all of which are weighing on 2019 growth.

Sectors Vary

How fast overall corporate earnings end up growing (or shrinking) in 2019 will likely be a major driver of stock market returns. Broad market ETFs like the Vanguard S&P 500 ETF (VOO) may take their cues from the aggregate earnings growth figures.

But within the broader market, earnings growth is anticipated to vary greatly. That could spur outperformance or underperformance for different sectors of the market.

In 2018, energy saw the fastest profit growth of the 11 stock market sectors. That was followed by materials, financials, communications services, consumer discretionary, industrials, health care, technology, utilities, consumer staples and real estate.

However, this year, energy and materials are expected to fall to the bottom of the pack, while industrials and consumer discretionary take their place. 

Tables source: FactSet

Earnings: Long-Term Driver

Over the long term, earnings are the lifeblood of the stock market, and tend to dictate where individual stocks, sectors and the broad indices go.

Still, investors should be mindful that, in the short term, the relationship between earnings and share prices can become disconnected, especially if investors anticipate an acceleration or slowdown in profits for future years.

Energy is a good example of that. It had the fastest earnings growth of all sectors in 2018, but stocks within the energy sector, as measured by the Vanguard Energy ETF (VDE), were the worst performers of the year.

A collapse in oil prices late in 2018 pushed expectations for 2019 earnings sharply lower, and the energy ETF tumbled in response.

Email Sumit Roy at [email protected] or follow him on Twitter sumitroy2