INSIGHTS BLOG

WILL EARNINGS SEASON MAKE OR BREAK THE CURRENT MARKET RALLY?

Mark Lister, 17 April 2019

Sharemarkets around the world have had a stunning start to the year, shaking off the worries of 2018 and rocketing right back up towards record highs. In the first three months of the year US shares posted the best quarterly gain since 2012 and the best March quarter since 1998.

This has all come on the back of central banks that are happy to keep interest rates at very low levels, as well as some improved economic indicators. Key manufacturing gauges in China and the US were better than expected last week, while the latest jobs report was strong enough to allay fears of any cracks in the US labour market.

However, for share prices to keep rising in a sustainable manner, we need one important ingredient to be added to the mix - earnings. In this regard, the next few weeks could make or break the current rally.

The quarterly reporting season started last week in the US, with some of the heavyweights of the financial sector kicking things off. From there, the rest of the market will report over the remainder of April and investors will be able to take the pulse of corporate America.

Earnings growth has been very strong over the last four or five quarters, in part due to the Trump Administration’s tax cuts that we implemented in early 2018. This helped push annual earnings growth to more than 20 per cent, levels we hadn’t seen since 2011.

However, things have changed. The one-off boost from the tax cuts is behind us, the global economy has slowed over the past six months, and higher oil prices and a tight labour market have added to cost pressures for many companies.

Put all of that together and you’ve got a recipe for weaker earnings growth, and much less upbeat headlines as the financial press reports on these. Aggregate earnings for the S&P 500 in the US are forecast to have fallen 3-4 per cent in the March quarter, the first decline since 2016.

In the scheme of things, this isn’t a major issue. The same quarter a year ago was a very strong one, making for a tough comparative period, and for the 2019 calendar year US companies should still report a five per cent rise in profits relative to 2018.

However, markets are fickle and they could well get despondent when we start seeing headlines about bellwether US companies experiencing lower earnings than this time last year, especially when share prices have clawed their way back to high levels.

Looking out toward the rest of the year, earnings trends are expected to improve. However, they’re still likely to be well below the spectacular levels of last year.

Be it property, farms or shares, the value of any asset is ultimately a function of its future earnings potential. If the outlook for company profits or rental earnings starts to look more muted, so too will the price buyers are willing to pay for that income stream.

On the other hand, if earnings reports exceed expectations and prove some analysts wrong, we could see the major indices push higher and even retest the highs from September last year.

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