A trader works on the floor of the New York Stock Exchange (NYSE) in New York, U.S. (Photographer: Michael Nagle/Bloomberg)

Traders Obsessed With S&P 500 Should Be Watching Another Number

(Bloomberg) -- It’s hard not to be transfixed by price screens amid the S&P 500’s worst stretch of the year. For insight on the longer-term health of equities, a different number will tell.

It’s the 2019 earnings estimate, whose topping out in September played a starring role in the meltdown that befell investors in the fourth quarter. Getting a handle on how President Donald Trump’s latest tariff campaign will affect corporate profitability has become a critical mission for investors wondering if this spell of volatility will stick.

So far, the forecast for earnings is holding up, though it’s too soon for analysts to have done much with their models after just two days of saber rattling. From a top-down perspective, UBS Group AG estimated that if talks break down and tariff hikes materialize, U.S. profits could contract 5 percent, wiping out growth this year and potentially hammering equities by 15 percent.

“Our base case remains for a negotiated trade settlement, including select U.S. tariff rollbacks in exchange for some Chinese concessions,” said Mark Haefele, UBS Global Wealth Management’s chief investment officer. “That said, we have continued to warn that US-China talks could still break down.”

Traders Obsessed With S&P 500 Should Be Watching Another Number

Should estimates swoon, an earnings picture that got slightly rosier over the last few weeks could dim. About 76 percent of S&P 500 companies have beaten estimates this season and fears of a profits recession have dwindled, as results and forecasts now call for earnings growth in the three months ended in March. But guidance has been skeptical at best, and full-year earnings estimates are still largely dependent on a fourth quarter boost.

Forecasts for S&P 500 profits this year peaked back in September at $177 a share, just before the market began its descent of near 20 percent. Since, estimates for earnings have fallen near 6 percent, and now stand at $166.70 a share.

If the tariff rate is raised, more downward earnings revisions to forecasts could be in the cards as companies deal with inflating prices. Throughout the first quarter reporting season, companies and executives have focused less on U.S.-China trade during conference calls, data compiled by RBC Capital Markets show. A higher tariff rate could change that.

“Beyond the blow to sentiment, we also get the impression that management teams and the sell-side community have only baked in the current tariff regime to guidance and stock level forecasts, meaning that any escalation of the tariffs could spark downward revisions to earnings expectations due to higher raw material/input costs,” said Lori Calvasina, head of U.S. equity strategy at RBC.

A change could also weigh on profit margins, measures of which, while at decade-long highs, have started to come under scrutiny as strategists call for a peak. To date, highly profitable technology companies have driven earnings among S&P 500 members to levels not seen since at least 1990, but the boost could shift to a detraction in the event of higher tariffs. Of all S&P sectors, tech and consumer discretionary companies have expressed the most concern over tariffs in previous earnings season, according to data compiled by Evercore ISI.

“An exogenous event like an escalation of the trade war would put upward pressure on input costs and weigh on profitability,” said Dennis Debusschere, the firm’s head of portfolio strategy. “Profitability will suffer significantly for the largest market cap sector if U.S. tariffs increase and China responds forcefully,” he added, referring to technology.

Traders Obsessed With S&P 500 Should Be Watching Another Number

Trump’s tweets saying that tariffs on $200 billion worth of goods could rise to 25 percent from 10 percent, and that another $325 billion in Chinese imports could be subjected to the tax, provided a harrowing if brief blow to calm Monday, in a stock market that had gone virtually nowhere but up this year. Then U.S. Trade Representative Robert Lighthizer confirmed higher tariffs would go into effect Friday, and stocks spiraled anew.

The S&P 500 fell as much as 2.2 percent Tuesday, again dragged lower by trade-sensitive technology and industrials companies. The Nasdaq 100 fell 2.4 percent as of 3:22 p.m. in New York, its fifth decline in six days, capping the gauge’s worst streak of the year.

Bluster is one thing, a hit to earnings are another. And Wall Street seems to be viewing the latest tweets as the former -- a tool of negotiation. China’s trade delegation is still coming to Washington for high-level talks this week. Strategists from Goldman Sachs Group Inc. to Citigroup Inc. shrugged off the concerns and remained positive a trade deal will be reached. There’s a similar take at J.P. Morgan Asset Management

“On the whole, we still expect a narrow trade deal, but there is a risk -- the risk is that markets priced that in to a large degree already,” Mike Albrecht, global macro strategist at JPMorgan Asset Management, said in an interview at Bloomberg’s New York headquarters. “So there is this large chance that you get a trade deal and a little bit of a bump to markets, but a small chance that you get a complete blowup and quite the sell-off.”

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