Third-Quarter Earnings Preview: What to Watch

Third-quarter earnings season effectively kicks off today, and it should be another good one. S&P 500 Index companies are expected to report their ninth consecutive increase in profits and third consecutive quarter with earnings growth of over 20%. We expect these strong earnings gains to be driven mostly by solid economic growth, particularly manufacturing, and tax cuts—though higher oil prices should give energy sector profits a nice boost. The interest rate environment has gotten better for financials recently, which also helps.

Another Quarter of +20% Earnings Growth Likely on Tap

We like looking at company pre-announcements ahead of reporting season to get a sense of where results may come in. At 2.1, the ratio of negative to positive pre-announcements for the third quarter is higher (or more negative) than the second quarter and last year’s third quarter, but lower than the long-term average of 2.8 (Thomson Reuters’ data since 1995). We interpret this as a positive indicator of upside to S&P 500 earnings estimates, but the potential upside is more modest than in recent quarters.

Similarly, earnings estimate revisions can tell us something about how results will come in. Third-quarter estimates have held steady since the quarter ended on September 30, but estimates were cut by 1.6% during the quarter. The good news is that the reduction in earnings is lower than the average reduction, suggesting that results will probably exceed estimates, as they typically do.

So what should investors be watching during earnings season? We highlight these three factors:

Profit margin pressure. In general, companies continue to do an excellent job controlling costs and keeping their profit margins high. But tariffs, (slowly) rising borrowing costs, and budding wage pressures have put the market on notice for potential narrowing of profit margins.

Profit growth peak. We will again hear about peak profit growth this quarter. A peak in earnings growth is very different from an earnings decline, something we see as a long way off. “Historically, about four years have passed, on average, between an S&P 500 earnings growth peak and the next recession, during which stocks have produced solid gains,” notes our Chief Investment Strategist John Lynch.

China-U.S. trade tensions. China will be important to watch again this earnings season given tariffs, the ongoing trade dispute, and related slower growth in the Chinese economy, which has pressured its stock market. We also expect to hear a lot about how companies are preparing for additional potential tariffs on Chinese goods, and whether they are seeing business in China drop off.

Look for more from us on third-quarter earnings in next week’s Weekly Market Commentary. Also, please follow our Earnings Season Dashboard for updates throughout earnings season.

IMPORTANT DISCLOSURES

Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company’s profitability. Earnings per share is generally considered to be the single most important variable in determining a share’s price. It is also a major component used to calculate the price-to-earnings (PE) valuation ratio.

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

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