US Q4 earnings season review

The 2018 quarter four (Q4) earnings season is almost done and dusted, and this means we can take a good look at how USA Inc is performing. Data from FactSet shows that:

1. From the S&P 500, 69% reported a positive surprise on earnings and 61% for revenue
2. Earnings growth for the period was 13.1%, and thus the fifth consecutive quarter of double-digit earnings growth
3. The forward price-to-earnings (P/E) ratio of the S&P 600 is 16.2, above the ten-year average of 14.7 but below the five-year of 16.4

Earnings estimates for the S&P 500 saw their largest cuts since Q1 2016. Estimates have steadily declined since the Q2 2018, but the decline has intensified, partly as a reflection of fears over the global economy and trade wars. But previous substantial revisions were in Q1 2015 and Q1 2016, neither of them particularly bearish periods.

Sales have continued to trend higher over the past eight years, with a smoother trend in evidence if the volatile energy sector is excluded. Meanwhile, margins have weakened, falling towards 11% for operating margins, from a high of 12.6% in 2017. This decline comes after steady growth from late 2015 into early 2018, as the recovery in oil prices boosted performance.

Since the Q4 2016, earnings have risen by 47%, ahead of the 24% gain for the overall index. This has also been the case for the twelve-month period ending 31 December 2018.

Looking into 2019, earnings are expected to grow by around 5%, in line with nominal gross domestic product (GDP) growth. A stronger US dollar will act to dampen sales growth, perhaps by as much as 2% points. Lower oil prices will also be a headwind for earnings growth for the year, as we saw in 2015. The effect of the US tax cuts of 2017/18 will continue to wear off in 2019, also weakening earnings growth to a degree.

Margins will likely weaken in 2019, if only because they spiked higher from late 2017. This kind of growth is unlikely to be repeated in the near term.

It is difficult to forecast what earnings for the next quarter will look like, and much will depend on whether trade wars intensify or fade from view. However, investors are not overly bullish, as seen by the ongoing outflows from US equity funds, and the downgrade to forecasts then makes it easier for companies to beat forecasts.

Q4 2018 may not have been quite as strong as other recent quarters, but like the economic picture, the corporate landscape is not currently suggesting a downturn in US growth is at hand.