The results: Profits declined 3.2% overall for the index. That’s the fifth quarter in a row of falling profits. The last losing streak of this magnitude was during the financial crisis of 2008-2009!
This is one of the prime reasons why investors are so nervous about the stock market at such lofty levels today:
The key support of profit growth is conspicuously absent!
And the story doesn’t get much better going forward, either.
Wall Street analysts have penciled in an S&P earnings decline of 2.1% for the third quarter … which would be the sixth straight quarter of falling corporate profits.
This has rarely happened outside of a U.S. economic contraction.
However, there is cause for some guarded optimism for a corporate profit recovery ahead. Last month in Money and Markets I wrote: “It pays to look more closely at the movement in earnings and sales estimates over the last several months…”<
In other words, I put more faith in the trend of forward earnings estimates, than in the actual results from looking backward, and you should, too.
Here’s where the story turns more bullish, especially for certain sectors of the stock market. The earnings revision ratio (ERR) for the S&P 500 has been in an uptrend recently.
This simply means more upward profit-estimate revisions as compared with downward revisions among S&P companies.
The one-month ERR improved to 1.13 in August, according to Merrill Lynch data, a sign of more upward than downward revision for the first time since May.
The technology sector of the S&P 500 was “most-improved” in terms of upside earnings forecasts last month (see chart above), with three-times more upward revisions versus cuts in August. That was the highest reading in six years!
It’s no wonder technology is also the best-performing sector over the past two months.
Healthcare, financial and utility stocks are likewise posting nice positive trends in profit forecasts. Also, multinational stocks that do big business in overseas markets are scoring the best upward revisions of all, compared with domestic-oriented stocks.
In fact, the one-month revision ratio for multinationals surged to 1.49 last month – meaning 3 upward profit forecasts for every 2 estimate cuts – that’s the highest since mid-2014.
The recovery in emerging markets plays a big role here, since these are some of the best customers for U.S. multinational companies. Technology, healthcare, energy and industrial companies all earn a large share of sales and profits from overseas.
The uptrend in earnings revisions is a bullish sign for corporate profitability going forward. Still, many investors are asking: When will the earnings recession ever end?
It’s a perfect excuse for sticking to the sidelines and staying out of the stock market, but perhaps the earnings recession is already coming to an end.
The government maintains an alternate calculation of corporate profits. It’s part of the quarterly gross domestic product (GDP) report.
And according to this data, we passed the low point in corporate red ink back in late 2015 (see chart above), with profits down more than 10% year-over year. Since then, it has improved.
True, profits are still in the red, according to the GDP data, but they’ve gotten progressively less-bad recently. The uptrend in Wall Street forecasts for S&P 500 profits is strong, confirming evidence of this improvement.
And what often matters most to financial markets is that things are improving (or getting less-bad) at the margin.
Handicapping the Fed: Want the inside scoop on what the Fed will do at their next policy meeting September 21? The key may be tomorrow’s non-farm payroll report at 8:30 a.m. Eastern Time. According to Bloomberg: “An overlooked line in Federal Reserve Chair Janet Yellen’s speech last week could hold the key to whether Friday’s U.S. jobs report clinches an interest-rate increase this month.”
Specifically, Yellen indicated that the decision to hike rates hinges on whether fresh data “continues to confirm” the economic outlook. In other words, we may not need a blowout jobs number tomorrow to seal the deal on a September rate hike, just an average gain will do.
The consensus forecast expects that 180,000 new jobs were added in August. That’s close to the average of 186,000 so far this year. Anything in the ballpark means rates could rise. And it will take a big swing-and-a-miss for the Fed to blink.
Factory funk: Speaking of misses, the U.S. Purchasing Managers Index (PMI) for August missed expectations by falling to 52 from 52.9 last month, indicating a very slow-growing American manufacturing sector. Slow growth in new orders and in employment were among the biggest drags.
China rising: Meanwhile, manufacturing activity in China picked up at a surprising pace last month. China’s PMI rose to 50.4 in August, the highest level in almost two years, and ahead of expectations.
Not only is China’s factory production outperforming the U.S., so is its stock market. Since July 1, the iShares China Large Cap ETF (FXI) is up 8.7% compared with a gain of just 3.2% for the S&P 500 Index.