With 19Q2 earnings season officially half way through, year-on-year (YoY) earnings growth for the S&P 500 has gradually improved throughout the quarter to 1.3% from 0.2% on July 1, 2019. While this may not sound overly exciting on the surface, it is pretty impressive considering that many feared 2019 would see an earnings recession, defined as two consecutive quarters of YoY earnings decline. Instead we are seeing positive YoY earnings growth despite the high hurdle set a year ago. As a reminder, tax reform, strong economic growth and low inflation lead to one of the strongest years on record in 2018, with earnings growth of 24.1% for the index.
Now that 59% of the S&P 500 has reported, the fact that we are still trending positive earnings growth this quarter is a significant accomplishment in itself, given the difficult YoY comparison (18Q2 earnings growth was 24.9%). However, we should remain cautious given the new economic picture of declining growth and manufacturing, inflation below 2%, and on-going trade disputes which have all contributed to expectations of a rate cut by the US Federal Reserve.
We have observed no shortage of commentary from CEOs discussing the impact of trade-disputes, tariffs, and a strong US dollar on business conditions and the supply chain. Using the StarMine Countries of Risk Model, we take a look at companies within the S&P 500 who have significant revenue exposure internationally vs. domestically to see the impact on earnings and revenue. Exhibit 1 shows the reality for companies who have large revenue coming from abroad (<50% of revenue from United States) with 19Q2 earnings and revenue growth of -9.7% and -4.1%. Comparing this to companies who are more domestically oriented (>50% of revenue from United States), they see 19Q2 growth rates of 6.4% and 5.2% respectively.
“Tariffs are counterproductive to efforts that encourage business growth and expand global trade … trade frictions have exerted a negative impact on sentiment and, of course, the manufacturing sector,” as Fedex Chief Marketing & Communications Officer Brie Carere points out. As a result, we are seeing how tariffs are changing both supplier and customer behavior.
At Intel, part of the growth in Client Computing Group came from a spur in orders as CEO Robert Swan mentions, “Tariffs and trade uncertainties created anxiety across our customers supply chain and drove a pull-in of client CPU orders into the second quarter.”
Meanwhile at Costco, the impact of tariffs has altered spending commitments with suppliers and possibly looking at alternative suppliers. “We’re accelerating shipments before certain tariffs were put into effect or would be increased in the percentage of the tariff, although there’s limited ability to do that. We’ve worked with suppliers. We’ve gone to potentially to every supplier on every item, as you might expect, to see what we can do to both reduce cost and figure out how to do that. In some cases, we’ve reduced order commitments on certain items. We’ve looked at alternative country sourcing where possible and feasible,” said CFO Richard A. Galanti.
A stronger dollar is also not helping companies whose revenue comes from overseas, as the revenues oversea decrease when translated back to the home currency. The DXY Index is up approximately 2% YTD, and reached a peak earlier this year in April which was not last seen since May 2017. Apple who reported earnings yesterday (July 30th) derives approximately 65% of their revenue from abroad. CEO Timothy Cook highlighted the impact of a strong dollar by stating “strong headwinds from foreign exchange, which impacted our top line growth rate by 300 basis points compared to a year ago. That’s equivalent to about $1.5 billion of revenue.”
Moving away from the S&P 500, let’s briefly look at the Russell 2000, which comprises of smaller-cap domestically focused companies (of the companies that provide geographical revenue data, 70% of companies have revenues greater than 50% coming from the United States according to the StarMine Countries of Risk Model).
Exhibit 2 highlights rapidly accelerating earnings growth that is expected to be strong in the second half of the year. These earnings growth expectations are significantly higher compared to the S&P 500. One possible reason for this could be that the stronger dollar is helping companies’ source supplies which are cheaper to purchase which helps improve the bottom-line.
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