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Earnings growth is slowing ... but that may be okay for stocks

Earnings season will be back next week, and companies have signaled fourth-quarter profit growth slowed from...

Posted: Jan 10, 2019 3:19 PM
Updated: Jan 10, 2019 3:19 PM

Earnings season will be back next week, and companies have signaled fourth-quarter profit growth slowed from earlier in the year. The question is whether investors have already priced that in.

It certainly appears that way.

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Apple (AAPL) warned last week that its holiday quarter sales would miss forecasts due to China softness. Apple and the broader market took a hit the day of its warnings. Since then, both Apple and the Nasdaq have surged nearly 8%.

Earnings news hasn't gotten much better.

Samsung, which competes with the iPhone maker but also sells chips that Apple uses in its devices, said this week its latest sales wouldn't be too hot either. Apple supplier Skyworks (SWKS) warned of softer sales and profits as well.

In the past few weeks, several other companies told investors to expect disappointing results, including Macy's (M), Corona owner Constellation Brands (STZ), Carnival (CCL) and FedEx (FDX).

So why have investors brushed aside many of these warnings?

People may simply be adjusting to the new economic and market reality. After earnings growth of more than 20% for the S&P 500 during the first three quarters of 2018, it's only natural that profits would slump a bit in the fourth quarter.

Sure, earnings growth is often very strong in the fourth quarter, thanks to holiday spending and companies rushing to spend what's left in their budgets at the end of the year.

But consider all the headwinds that consumers and businesses had to face in the past few months: Worries about trade tension with China. Slowing global economic growth. Rising interest rates.

Still, fourth quarter earnings should still be pretty good.

Wall Street analysts predict profit for the S&P 500 will be up more than 11%, according to FactSet. Profits could wind up rising by more than 15%, because more companies tend to beat forecasts than miss them, noted FactSet senior earnings analyst John Butters said in a report that.

"The market sell-off at the end of last year was overdone," said Carlos Dominguez, president and chief investment officer of Element Pointe Advisors.

Dominguez thinks investors might flock back to some big tech stocks as they start to realize that earnings growth should still be strong for companies that aren't exposed to slowing smartphone sales.

Growth is slowing but that isn't the end of the world

For example, the bad news for Apple shouldn't necessarily mean that Netflix will have a lousy quarter.

Still, the market is going to be watching closely for clues about the 2019 outlooks. Are companies going to be hit by tariff concerns and other major macroeconomic concerns?

So far, the guidance for 2019 is not looking too encouraging. Analysts expect annual earnings growth of just 7.4% and revenue growth of 6% for the S&P 500, according to FactSet.

That would be a big letdown after this year. But the market may have already adjusted for this -- and stocks may now be tantalizingly cheap as a result.

John Lynch, chief investment strategist with LPL Financial, noted in a recent report that the S&P 500 was trading for less than 14 times earnings estimates following the huge market sell-off on Christmas Eve. At the start of 2018, stocks were valued at more than 18 times profit forecasts.

That's a significant pullback in valuations, one that Lynch believes is only justified if the economy was about to go into a tailspin.

"We believe the outlook for economic and corporate profit growth is simply better than stocks are pricing in," Lynch wrote.

Dec Mullarkey, managing director of investment strategy for Sun Life Investment Management, agrees.

"Market anxiety will be lowered," Mullarkey said. "Investors should take comfort that things still look strong in America."

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