24 June 2017, New York — Heading into second-quarter earnings season, investors are looking for a continuation of strong U.S. company results to justify high stock valuations, now trading near their loftiest levels since 2004.
However, drilling a hole into that hopeful scenario is the current bear market in oil prices and an economy showing signs of growth below the pace expected earlier in the year.
“A lot of the expectation for a recovery in earnings is predicated on oil prices being around $47-$50 a barrel,” said Hugh Johnson, chief investment officer of Hugh Johnson Advisors LLC in Albany, New York. “So if you don’t get those numbers, you don’t get the strong earnings the stock market needs. This is not trivial stuff. It creates a lot of uncertainty and volatility in forecasts.”
U.S. crude futures CLc1 have been pressured lower by a supply glut. They’ve averaged over $48 per barrel so far this quarter, but traded around $43 on Friday and are down more than 20 percent from February when they hit an 18-month high.
U.S. stocks are in the ninth year of a bull run which has been fueled of late by bets on pro-growth policies from U.S. President Donald Trump. However, with the timetable for reforms stretching further into the future, earnings are seen as a critical support for stock prices.
With indexes near record highs, there is speculation among Wall Street analysts about whether a correction is due.
Earnings expectation have dropped for 10 of 11 industry groups since early April, with only industrials looking better than they did then.
The benchmark S&P 500 stock index as a whole is expected to deliver 7.9 percent profit growth, down from 15.3 percent in the first quarter, and below the 10.2 percent forecast in April, Thomson Reuters data shows.
On Thursday, Nike (NKE.N) will be the first Dow component to report earnings for the most recent quarter. The season heats up in the second week of July.
Technology earnings are seen posting double-digit growth, helped by gains in semiconductor companies, and financials are close behind with estimated 8.1-percent profit growth.
While lower energy prices can help some sectors such as industrials and transports, as well as boosting consumer sentiment, high expectations for energy earnings growth mean any stumble will be felt broadly.
Energy sector profits are seen up a whopping 683 percent from a year ago, when many companies posted losses, according to Thomson Reuters data. Without energy, profit growth estimates drop to 4.8 percent for the quarter.
Expectations for the sector will probably have to come down for the second half of the year if low oil prices persist, said David Joy, chief market strategist at Ameriprise Financial in Boston.
“The one wild card right now is the price of oil. Expectations that are baked into full-year forecasts assume a higher price for oil certainly than we have now,” he said.
Energy has been the weakest performing sector so far this year, with the S&P energy index.SPNY down near 15 percent.
The drop in oil prices notwithstanding, some analysts have cautioned that Wall Street has been too optimistic about overall earnings.
Michael Purves, chief global strategist at Weeden & Co, cut his 2017 S&P 500 earnings estimates from $127 to $116, below the $131.51 consensus, as economic growth and inflation are not as high as expected.
“I’m looking for CEOs to start taking down their forecasts for the year,” Purves said.
In fact, the Citigroup U.S. economic surprise index.CESIUSD, a gauge of economic data compared to expectations, this month fell near a six-year low.
An Atlanta Federal Reserve model recently forecast second-quarter economic growth coming in at a 2.9-percent annualised pace, down from a previous 3.2 percent.
Another hurdle for earnings growth: declining corporate buybacks.
“Over the past two years, more than 20 percent of S&P 500 issues have given at least a 4 percent tailwind for (earnings per share) via reduced share counts,” Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, said in a note.
For the first quarter of 2017, that rate fell to 14.8 percent of companies, and there are indications of “even less support” in the second quarter, he said.
*Caroline Valetkevitch & Rodrigo Campos; Megan Davies; Editing: Daniel Bases & Nick Zieminski – Reuters