Stock Bulls Groove to Powell as Earnings Outlooks Play Sour Note

(Bloomberg) -- Given the trajectory of U.S. equity prices, it’s fair to say earnings season is not proving an obstacle to bullishness in the market. But one plot line in the profit story bears scrutiny.

Stocks in the S&P 500 just rose for the sixth time in eight weeks, jumping another 1.7% and finishing at a record. They did so during a period in which weakening company outlooks led analysts to cut earnings estimates for the rest of the year. By one measure, guidance for the third quarter has been some of the worst in a decade.

The obvious offset to the dimming profit picture is Jerome Powell’s Federal Reserve, whose newfound dovishness has driven a $6 trillion rally in American equities during 2019. Investors preparing to celebrate a rate cut when Powell & Co. meet next week might ask themselves if profit growth is one of the things crying out for stimulus.

“It’s not only about interest rates,” said Rich Sega, global chief investment strategist for Hartford, Connecticut-based Conning, which has about $145 billion in assets under management. “People have been scaling back their forward guidance. It points out a potential conflict.”

To be sure, earnings have looked just fine for the quarter ended in June. Three-quarters of companies have beaten analyst estimates, a trend that keeps full-year estimates relatively steady. Strip out those unexpectedly strong results, however, and the second-half picture dims.

Among 35 companies that have revised guidance for the third quarter, 60% have slashed it, a rate that ranks with the worst since 2011, data compiled by Bloomberg show. At this point, only one company has issued a higher profit outlook for the third quarter -- Netflix Inc., which still suffered its worst post-report reaction in three years in the wake of disappointing subscriber numbers.

Before the bulk of the earnings season began last week, analysts were calling for profits among S&P 500 companies to rise 6.5% in the last three months of the year. Now projections stand at 5.2%, according to Bloomberg Intelligence data. The reduction is small but noticeable in a market with as much good news priced in as this.

Still, investors haven’t freaked out when companies have warned of a bleaker future. Share price reactions to negative changes have been muted, according to Bernstein analysts. In the 48 hours after reporting earnings, companies that lowered profit guidance only saw their shares fall by 0.7% on average.

In a twist that demonstrates how much cover expectations for stimulus are providing, companies that have cut revenue guidance this season actually gained more than those that raised.

Container-board company Packaging Corp. of America, for example, posted earnings for the second quarter that were better than feared while lowering its estimate for the third. Its stock price barely budged. When Honeywell International Inc. released earnings July 18, the industrial giant gave a lackluster top-line forecast for this quarter, and shares rose more than 3%.

“Most companies if they don’t really blow it, they’ll probably get somewhat of a pass if for no other reason than the Fed’s going to cut rates,” Jason Browne, president of Alexis Investment Partners, said in an interview at Bloomberg’s New York headquarters. He’s been reducing risk levels and raising cash. “The problem is going to come sometime in the next couple of weeks when we’ve gone up to highs, we get the catalyst behind us in terms of whatever the Fed happens to do and get through earnings season, and then the question is, ‘Now what?”’

The Nasdaq 100 jumped 2.3% this week as strong earnings releases from the likes of Google parent Alphabet Inc., Starbucks Corp. and Texas Instruments Inc. helped send the tech heavy benchmark to record highs. On the other hand, the Dow Jones Industrial Average ended the week largely where it began as fallout from its largest constituent, Boeing Co., weighed.

Next week could be a pivotal one for U.S. stocks that by some measures look a bit expensive. Nearly 170 companies in the S&P 500 are set to report, making it the busiest week of the entire earnings season. Some of the largest companies, including Apple Inc., The Procter & Gamble Company and Mastercard Inc. are on the list. The Federal Reserve is also expected to cut interest rates when they meet, and a fresh batch of jobs data will be released Friday.

“Next week is not necessarily going to determine your framework in terms of what’s happening with earnings, but next week will be important in terms of the Fed,” said Chris Zaccarelli, chief investment officer for Independent Advisor Alliance. “And I really think the Fed and trade are really the big macro issues that are impacting all investments at this point in time.”

--With assistance from Wendy Soong and Elena Popina.

To contact the reporters on this story: Sarah Ponczek in New York at sponczek2@bloomberg.net;Vildana Hajric in New York at vhajric1@bloomberg.net

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

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