Mark Lister, 17 July 2019

Shares have had a phenomenal run this year, especially in the biggest market of all, the US. The Dow Jones Industrial Average pushed through 27,000 points last week, while the broader S&P 500 closed above 3,000 for the first time ever.

During the first six months of this year, the S&P posted a gain of 17.3 per cent. That’s the strongest first half we’ve seen since 1997, and the gains have continued through the first half of July.

Assurances of supportive monetary policy from the Federal Reserve have been a big factor in the turnaround from last year’s malaise, but there could be a new challenge for markets during the next few weeks.

The June quarter reporting season begins over the coming days, and we’ll find out if corporate profitability has been good enough to live up to the all-time highs many share prices have risen to.

There’s every chance it’s a fairly ugly one. Economic growth has slowed virtually everywhere, while trade tensions between the US and China have added a healthy dose of uncertainty to a number of industries.

A buoyant US dollar will have also been a headwind. The greenback was around five per cent higher in the three months ending June 30 than it was in the same period a year ago. Almost 40 per cent of revenues from S&P 500 companies come from outside the US, and exporters will have felt the effect of a stronger currency.

Sharemarkets look forward, rather than backwards, so outlook statements are always crucial when it comes to company results. Given the plethora of uncertainty the world is facing, management teams might find it difficult to be overly optimistic.

We’ve seen these signs amongst those that have reported early. Economic bellwether FedEx warned of slowing activity, while consumer heavyweight Nike noted the impact of a stronger currency on an otherwise solid result.

Some good news is the fact that none of this should be much of a surprise to anyone. Analysts are expecting S&P 500 earnings to fall by three per cent in the June quarter, which would mean two consecutive quarters of declining profits for the first since 2016.

For 2019 on the whole, analysts have cut their profit expectations by around five per cent since the beginning of the year. Forecasts now suggest the US sharemarket will grow earnings by a meagre 2.4 per cent. That’s still positive, but it’s a far cry from the rampant 20 per cent earnings growth we saw in 2018.

Back then economic growth was looking better, the US dollar was weaker and the trade war hadn’t escalated quite as badly. Then again, interest rates were moving steadily higher a year ago, and today the Fed is talking about how much it will cut.

Markets will be hoping current estimates are on the conservative side. In the last five years actual results have ended up 3-4 per cent higher than forecasts have suggested, so it’s still possible we see quarterly earnings growth squeeze into positive territory.

Another point for the optimists is that despite being at a record high, US shares are only 2.8 per cent above last year’s peak.

The year to date return of more than 20 per cent sounds phenomenal, but remember the S&P 500 tanked almost 20 per cent in the last three months of 2018. That correction bottomed out on Christmas Eve, just four trading days before the end of the year.

That means all this talk of the huge 2019 rally is a little misleading. Over the past year, US shares have gained 7.6 per cent, which sounds much more ordinary. It should, because that’s pretty much the long term average.

About a tenth of the US market report results this week, including some of the heavyweights. Every reporting season is important, but it feels like this one is a bit more ‘make or break’ than usual.