Key Takeaways from Fourth Quarter Earnings

Earnings growth slowed in the fourth quarter but was still solid. With two-thirds of S&P 500 Index companies having reported results so far, corporate America has delivered solid earnings growth—in the mid-to-high teens—for the quarter. However, slowing global growth and trade tensions have challenged the outlook, setting up slower earnings gains in the coming year. This week we provide key takeaways from fourth quarter earnings season, and update our 2019 earnings outlook.

THE NUMBERS

Year-over-year earnings growth for the fourth quarter is tracking near 17%, one percentage point above the growth rate reflected in year-end estimates (source: Refinitiv, formerly Thomson Reuters). This is solid growth, but below the 25% pace of the prior three quarters [Figure 1]. Tax cuts boosted earnings growth by 7–8 percentage points. Revenues (which are not impacted by the tax cuts) are tracking to a healthy 6% increase, similar to prior expectations.

Companies in the communication services, energy, and industrials sectors produced the most upside to prior estimates. Energy and communication services, in that order, made the biggest contributions to earnings growth. Upside was limited by the financials and technology sectors, which came up short.

Forward-looking guidance has been tepid overall during reporting season, mostly because of the uncertainty surrounding the U.S.-China trade dispute and slower growth overseas. U.S.-focused companies have delivered stronger revenue and earnings growth than more global companies, according to analysis by FactSet, while consensus S&P 500 earnings estimates for the first quarter were cut by an above-average 4.6% in January, as shown in Figure 2. Excluding energy, though, the reduction has been typical.

KEY TAKEAWAYS

Our key takeaways from the quarterly results received so far are:

1. Upside is tougher to come by. At this late stage of the economic cycle, it is tougher for companies to produce big upside surprises. Slower growth overseas, particularly in Europe, makes it even more difficult, which means we should probably expect 2–3% upside, rather than the recent 3–6% range, to be the norm going forward.
2. The bar for 2019 has been lowered substantially. The more-than-4% cut to consensus first quarter earnings estimates—to near flat with the prior-year quarter—sets companies up to surprise on the upside when first quarter results start being reported in April. After cutting overall S&P 500 estimates for 2019 by about 3%, analysts are now factoring in only a 4–5% increase for the year, including flat technology sector earnings.
3. Trade uncertainty is a headwind. Based on management commentary this quarter, most companies are feeling an impact from the China trade dispute, either through tariff costs, supply chain disruptions, dampened consumer and business confidence, or simply less demand for U.S. goods in China. Until this uncertainty is lifted and tariffs are reduced or eliminated, current estimates may be difficult to achieve.

THE OUTLOOK

Earnings growth will likely slow in 2019 as the one-year anniversary of the tax cuts passes. Still, we think that S&P 500 companies will be able to at least deliver mid-single-digit earnings growth in 2019 due to the following:

Solid domestic economic growth. Our forecast is for U.S. GDP growth of 2.5–2.75% in 2019, supported by increased consumer spending, business investment, and government spending. The booming January jobs report, including steadily rising wages, reaffirms the strength of the consumer. January readings of the Institute for Supply Management (ISM) surveys on manufacturing and services, both in the 56–57 range, signal near-term earnings gains.

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