Thought of the week

The 1Q19 earnings season is under way; with 25 companies having reported (4.6% of the market cap), our current estimate stands at $36.42. This represents a -0.3% growth rate from a year prior, a sharp decline from the robust pace of earnings growth observed in 2018.

This deceleration stems from issues with both sales and margins; first, nominal GDP, a good proxy for sales, likely slowed in 1Q19 due to the fading effects from tax reform, a reduction in global manufacturing and trade, lower inflation and the U.S. government shutdown. Margins are facing their own set of headwinds. Rising wages and raw materials costs are putting downward pressure on margins, and look unlikely to be offset by pricing power as inflation figures remain quite soft. Finally, taxes will also play a major role in determining where margins shake out at the end of the quarter.

Earnings in 2018 benefited from lower taxes, which essentially lowered company costs and artificially expanded margins. However, now that companies are likely to have the same effective tax rate as they did last year, this artificial boost will fade. Given this backdrop, 1Q19 looks to be a challenging quarter; that said, estimates appear to have overshot to the downside, creating opportunity for earnings beats that typically help the market push higher. Furthermore, if these beats push earnings into positive territory, that should provide more durable support for the market going forward.