July 16, 2019

Breakingviews: U.S. corporate earnings lose their tax-cut mojo

by Breakingviews.

The S&P 500 Index closed at a record high on Friday. Yet second-quarter earnings, which kick off in earnest this week, are expected to shrink from last year – the first such decline for three years. Twelve months ago, prognosticators thought S&P 500 profit for the most recent quarter would rise more than 10%, according to data from Refinitiv. The same people see earnings growth back in double digits in 2020, but they could be wrong again.

The four 2019 earnings seasons were always going to face what are known in the jargon as tough comps. That’s because 2018 was a blowout year thanks to the corporate tax cuts signed into law by U.S. President Donald Trump. With no other change, they improved a hypothetical U.S. company’s after-tax profit by around 22%.

The bigger question is what happens in the future. As things stand, analysts see margins being squeezed. They expect profit of S&P 500 companies to be down 0.3% in the quarter to June even as revenue grows by 3.3%. Yet the top-line prognosis has worsened too. One year ago, they expected the top line to be up nearly 5%.

For the first quarter of 2020, sales are projected to increase over 5% year-on-year and earnings 10%. It’s hard not to see greater downside risks than upside, though, whether in the form of trade friction with China, Mexico or even France, a U.S. economic slowdown, or a further downgrade to growth outside the United States. A less rosy top-line result would naturally knock earnings.

In other words, what some like to call the earnings recession that’s set to start with the current round of results may last longer than a single quarter. It’s hard to see how record stock prices, which are supposed to reflect market-watchers’ collective best guess at the future, are compatible with that. Similarly, if companies continue to buy back less stock, as they did in the first quarter relative to the fourth-quarter 2018 peak, according to S&P Dow Jones Indices, that’s another reason to worry valuations may lack support.

If share-price indexes are the yardstick by which Trump really measures his success, any satisfaction stemming from Friday’s figures may prove short lived.

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