February 4, 2019

Wall Street braces for its first profit plunge in three years

Stocks are booming because investors care a lot more about corporate profits on Wall Street than any drama in Washington. But company earnings could soon take a turn for the worse.

Profits for S&P 500 companies are expected to decline nearly 1% during the first quarter compared to the same time period last year, according to estimates from FactSet Research. If that happens, it would be the first overall drop in earnings since the second quarter of 2016.

Profits rose more than 20% in the first half of 2018 when lower corporate taxes helped juice growth, which helped drive the market. And stocks are climbing this year in part because fourth quarter earnings were better than expected. (The Fed's insistence that it will be "patient" about future rate hikes has helped, too.)

That all may change when Wall Street reports first quarter results this spring. While investors know they probably won't get a repeat of last year, the booming stock market suggests they may be focusing on year-end successes instead of on what's to come.

Many companies have already warned their shareholders about the early months of 2019. Tool maker Stanley Black & Decker, Netflix, telecom equipment firm Juniper Networks and oil producers Valero and Noble Energy have all slashed their first quarter outlooks in recent weeks.

What's more, the Fed's sudden shift regarding rate hikes might actually be a bad omen.

"If the Fed's assessment is correct, that the economy is slowing faster than expected, this could cause additional markdowns to 2019 earnings forecasts," said Baird investment strategists Bruce Bittles and William Delwiche in a report Monday.

Is the worst of the earnings slowdown already baked into market?

Some investing experts think the expected earnings pullback is overblown.

Most of the companies that have reported warnings so far are in energy and technology, wrote David Lefkowitz, senior Americas equity strategist at UBS Global Wealth Management's chief investment office, in a report Monday. That caution, he said, can be explained by the drop in oil prices last year, as well as weaker demand for smartphones.

Estimates for companies in other sectors --- including banks, health care and retail --- remain relatively stable, wrote David Bianco, chief investment officer and strategist for the Americas at DWS, in a separate report.

Unless Corporate America starts warning of weaker profits more broadly, that means investors might dismiss any first quarter weaknesses as a one-off.

In fact, analysts predict that overall, profits will be up nearly 6% in 2019. That's because even if profits fall in the first quarter, they expect a big comeback at the end of the year.

In any case, a profit slowdown in the first quarter is to be expected as the effects of the tax cuts fade, wrote Katie Nixon, chief investment officer of Northern Trust Wealth Management. But she added that the results should still be "good enough" to keep investors happy.

The stock market fallout at the end of 2018 might have also helped investors put things in perspective. Back then, fears that the Fed would keep hiking rates and that the United States and China wouldn't reach a trade deal drove all three major indexes down about 20% from their fall highs.

"The profit decline in the first quarter is not that much of a worry," said Gertjan van der Geer, senior investment manager of thematic equities with Pictet Asset Management. "Expectations have come down. We're positive on the second half of the year as China bottoms out and valuations look okay."

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