All the News Is Bad News as Stocks ‘Flip the Switch’ on Earnings

(Bloomberg) -- Throughout the bull market, earnings season has been a refuge for investors, a quarterly reassurance that all is well in corporate America. This time around it’s been anything but.

Look at Caterpillar Inc., plunging 9.4 percent after saying third-quarter income rose more than expected. Same thing with Harley Davidson, and with United Rentals Inc. last week, which lost 15 percent after sales and income exceeded targets. It’s been the story of equities all month, currently shaping up as the worst October in a decade.

While often a haven, earnings season can also be a dicey proposition for traders: however good the news, most of it is known before companies start reporting. The big judgments are rendered not on headline numbers but the sometimes-ambiguous pronouncements executives make about the future, on things like margins, trade and currency.

Right now, none of those things are going bulls’ way. Almost a quarter of S&P 500 companies have reported results, and even though all but 15 exceeded forecasts, their stocks lost an average 0.5 percent the day after, data compiled by Bloomberg showed.

“After having had so many quarters where any little bit of bad news was discounted, we’ve now flipped the switch and gone totally the other way,” said Peter Jankovskis, co-chief investment officer at Oakbrook Investments, who owns shares of Caterpillar and 3M. “People are just talking about that somewhere in the future things will be bad, things are great now, and then the stock gets punished.”

Everyone wants earnings to be a calming force in times of stress and hopes were high they’d do the same this time around. Wall Street was never surer about what companies would say: the difference between the highest and lowest per-share profit forecast from stock to stock was 5 percent on average, the narrowest since 2000, Bank of America Corp. data show.

For a host of reasons -- and despite companies making good on forecasts -- calm hasn’t been restored. Most pressing has been the number of companies discussing an issue tied to the strength of the economy itself: rising costs, for everything from freight to labor to raw materials. Caterpillar mentioned it, as did United Rentals, as did Fastenal, Sealed Air Corp. and PPG Industries.

Amid a backdrop of interest rate volatility, President Donald Trump’s trade war and geopolitical flareups from Italy to Saudi Arabia, anxiety is rife around a central pillar of the bull case: next year’s estimates. For the first time since Trump’s tax overhaul was passed, they’re falling, going from $177 a share in the S&P 500 last month ago to $176.6 now.

“What’s happening in the markets right now is a fundamental repricing of earnings expectations,” Gina Martin Adams, chief equity strategist at Bloomberg Intelligence, said on Bloomberg Television. “It’s about margins and contending with higher prices, more spending. What does the operating market look like? What does the outlook look like in 2019? Those are the questions we’re asking ourselves and that’s what’s creating the weakness in stocks.”

The S&P 500 Index fell 2.2 percent on Tuesday to 2,697, the lowest level since May. The Nasdaq 100 Index plunged 2.2 percent, while the Cboe Volatility Index spared to 24. A 9.4 percent slump in Caterpillar pushed the Dow Jones Industrial Average down by 2.1 percent.

To be sure, the earnings companies are reporting for the third quarter are stellar by any historic measure. Estimated at about 21 percent, growth for S&P 500 companies is poised to be among the highest of the bull market. But growing concern about rising costs crimping profit margins and higher yields feed into the prevailing fear over peak profits. Earnings are projected to grow 11.5 percent in 2019.

“We still have this quarter and maybe next quarter to look at earnings growth, but profit margins clearly are just going to start peaking very soon, maybe this is it,” said Omar Aguilar, chief investment officer for equities at Charles Schwab Investment Management. “EPS estimates will have to come down.”

Caterpillar, an economic bellwether, tumbled despite reporting its best ever third-quarter results. The mining and construction equipment maker said manufacturing costs were higher due to rising material and freight costs, something its attributed to increasing steel prices and tariffs. The company informed dealers that it would be raising pries on some products 1 to 4 percent starting in January.

Industrial stocks “are having a hard time living up to heightened expectations,” said Larry De Maria, an analyst at William Blair & Co.

Diversified industrial manufacturer 3M Co. sank the most in six months as adverse exchange-rate moves and high material prices compounded slumping sales in its electronics, health-care and consumer products businesses. Harley-Davidson Inc. tumbled as much as 6.7 percent after posting the steepest decline in U.S. retail sales in more than eight years.

“It’s going to be hard for American companies to continue growing profits double digits,” said Andy Kapyrin, director of research at RegentAtlantic, which has $3.7 billion in assets under management. “U.S. stocks don’t have much room left to run. Doesn’t mean they’ll fall, but a repeat performance of this year isn’t likely."

--With assistance from Polina Noskova and Joe Deaux.

To contact the reporters on this story: Sarah Ponczek in New York at sponczek2@bloomberg.net;Elena Popina in New York at epopina@bloomberg.net

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Chris Nagi

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