Corporate Earnings Take A Hit From Trump’s Trade War

• Uncertainty over the trade war with China slows economic growth forecast
• After exceeding the fair value target in July, stocks have struggled with trade uncertainty and recession fears related to the inverted yield curve.
• Long-term interest rates have dipped below short-term rates, historically a leading indicator of recession
• “These forecasts reflect increasing odds of a prolonged trade conflict and of recession in the latter half of 2020.”

The LPL Financial has lowered their 2019 S&P 500 Index earnings growth forecast. Their revised S&P 500 EPS forecast is now $165 for 2019, compared to an initial 2020 forecast of $175. LPL has maintained their year-end fair value target on the S&P 500 of 3,000. John Lynch, chief investment strategist at LPL said, “We expect lower interest rates and inflation to support higher valuations.”

The trade conflict is weighing on earnings in several ways:

• Slower economic growth hampers revenue, while paying tariffs and dealing with supply chain disruptions hurt profit margins.
• Business uncertainty around future trade actions weighs on capital investments, which limits opportunities for companies to grow revenue, and caps gains in productivity (output per hour worked) that could boost profit margins (more output per hour means companies can do more with fewer resources and contain wage increases).
• Slower growth in international developed economies has added to near-term pressure on the U.S. economy and therefore on companies’ revenue.

Preliminary 2020 Forecasts             

In August, LPL initiated preliminary S&P 500 EPS forecasts for 2020 of $175. “At this point, we expect modest 1.75% GDP growth, 2–2.25% on the 10-year Treasury yield, $175 in S&P 500 EPS, and a range of 3,150–3,200 for S&P 500 fair value at year-end 2020,” Lynch said. “Our forecasts for GDP and the 10-year yield are near consensus while our EPS projection is currently $8 below the consensus ($183) estimate. These forecasts reflect increasing odds of a prolonged trade conflict and of recession in the latter half of 2020.”

2Q

“We would say the most important takeaway from the now-completed second quarter earnings season is that earnings are still growing and an earnings recession appears to be off the table for now,” Lynch said. According to FactSet, the S&P 500 Index overall produced flat EPS year over year, other sources such as Refinitiv reported operating earnings growth of over 3%.

“Overall, we think corporate America has done a good job delivering modest earnings gains amid significant headwinds, including tariffs and trade uncertainty, slowing growth in Europe and Japan, and a strong U.S. dollar,” Lynch said. “Roughly 40% of S&P 500 profits are generated overseas and are therefore sensitive to global trade, international economies, and foreign exchange markets.” Over the past two months, EPS estimates for the next four quarters fell about 2%, in line with historical averages and an impressive feat given the various headwinds.

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Final Thoughts: LPL reduced their 2019 S&P 500 EPS forecast in August to reflect increased risk to economic growth and corporate profits from the ongoing trade conflict between the United States and China. Although experts continue to expect resolution later this year or in early 2020, the odds of a more prolonged dispute have risen. “We believe it is prudent to be somewhat conservative in our forecasts until we get more clarity on trade,” Lynch said.