The economic backdrop in 2019 has been characterized by weakness in manufacturing being offset by the resilience of services and the health of the consumer.
However, the past few weeks have seen a deceleration in the pace of employment growth and a notable softening across the non-manufacturing sector. The idea that this expansion will continue has been predicated on manufacturing weakness remaining contained, but this dynamic is increasingly being called into question.
With that as the backdrop, 3Q19 earnings season is getting underway. With 21% of S&P 500 market capitalization
having reported, our current estimate for 3Q19 operating earnings growth is -2.6% from a year prior. 90% of companies that have reported beat earnings estimates, while 48% have beaten sales estimates. Margins appear to have contracted on a year-over-year basis to a level of 11.6%, but are still up from last quarter. Finally, buybacks look set to add about two percentage points to the overall level of earnings growth, providing a partial offset to the decline in margins.
From a sector standpoint, the bright spots are few and far between. Financials look set to struggle on the back of weak capital markets activity, lower interest rates and a flatter yield curve. The globally exposed sectors like technology, industrials and materials will all see a drag from a stronger U.S. dollar, as well as slower global growth. Finally, energy is being hit by lower oil prices, but we expect the trend of returning cash to shareholders through buybacks and dividends to continue. While positive earnings growth in the healthcare and utility sectors will partially offset some of these drags, it is unclear whether they will do so entirely.
In general, the outlook for third quarter earnings growth is a bit cloudy. Operating earnings have grown at an average pace of around 4% so far this year, but the hurdles facing the 3Q19 earnings season are quite high. 3Q18 saw profit margins peak at a level of 12.1% with earnings per share up 32% from a year prior, and these challenging base effects and margin dynamics have led analyst estimates into negative territory over the past few weeks. Applying the average earnings surprise since 2012 suggests that earnings growth may shake out in the low single digits when all is said and done, but at the current juncture, the risks feel tilted to the downside.
S&P 500 earnings contribution by sector
Related: Where Are Interest Rates Going from Here?