On Wall Street, companies are lining up to deliver their earnings reports for the third quarter. Solid earnings growth has been a key driver of the bull market that began in March 2009, but recently the momentum has faded. And this quarter will be nothing to write home about, forecasts suggest. The profits of S&P 500 companies are expected to fall by 5% year-on-year. If that proves accurate, it will mark the first time since 2009 that earnings have fallen for two quarters in a row.
One problem remains the strength of the US dollar. The dollar index, which tracks the greenback’s progress against a basket of its major trading partners’ currencies, hit a 12-year high in March. It has traded sideways since, but unless it weakens significantly, it will continue to squeeze US company earnings, says John Authers in the Financial Times. S&P 500 firms make around half their sales abroad.
Meanwhile, the energy sector, which accounts for around 8% of the index, is dragging overall earnings down as the oil price slides. The sector’s profits are set to have fallen by an annualised 65% in the third quarter. The slowdown in China and emerging markets is another hurdle. But a new problem is falling profit margins, say Saumya Vaishampayan and Corrie Driebusch in The Wall Street Journal.
Since the crisis, companies have slashed costs, put off investment in infrastructure and borrowed at historically low rates. “The upshot was several quarters of higher profits, even as sales stagnated.” The “bumpy, below-par and brittle” recovery, as Morgan Stanley puts it, has kept a lid on sales growth. Now “the margin story is crucially important to the earnings outlook because we’re not expecting a ton of revenue growth”, says Matthew Peron of Northern Trust.
That’s something of an understatement: we’re not actually expecting any revenue growth. Sales are projected to fall by 4% year-on-year. There’s also a limit to how much profit growth firms can squeeze out of tepid sales – and we’ve probably reached it. Margins – earnings as a share of sales – reached a record 10.5% for the S&P 500 in the second quarter and are on their way back down. The index’s margin will fall to 10.1%, analysts reckon.
Dwindling margins don’t exactly “bode well for justifying where price/earnings multiples are today”, as James Abate of Centre Funds notes. Pricey stocks and falling earnings are an unappealing mix.