It’s only Monday, but investors are already anticipating another big week of corporate earnings. After J.P. Morgan Chase, Bank of America, Netflix, and Citigroup beat out analyst expectations last week, market confidence is riding high.
And though 80% of reporting S&P companies surpassed estimates, there are still a few skeptics out there who aren’t buying the hype – potentially for good reason.
“Q3 earnings season so far is not as strong as the headlines indicate,” said Nicholas Colas, co-founder of DataTrek Research, in a note to clients.
“Yes, Q3 earnings reports have been good thus far […] But the amounts of these ‘beats’ on the bottom line are smaller than usual, even as revenues are actually better than expected.”
Based on the first round of reports, analysts polled by FactSet now predict a 4.7% decline in Q3 earnings relative to last quarter. If they’re right, investors could be ready to sell after blue-chips announce earnings by the end of the month.
And despite the recent talks in Washington, the trade war remains an ever-present source of uncertainty – providing yet another reason to “go bearish” should earnings disappoint.
“A credible and sizable positive trade announcement could expedite a turn for the better, although there is no sign of such an outcome,” said MRB Partners strategists in a note.
“There is considerable uncertainty on many fronts, including weak global trade and manufacturing activity, a generally protectionist trade backdrop, and many domestic and international political hotspots.”
It’s that uncertainty – something we (and many others) have mentioned repeatedly – that could have a profound effect on stocks for the remainder of the year, and possibly throughout the entirety of 2020.
Not just because investors will be worried, though. Instead, uncertainty could reduce stock buybacks – a trend that appeared in Q2 when S&P companies repurchased $161 billion in shares, 18% less than in Q1.
And over the course of Q3, it’s only gotten worse. Year-to-date, buybacks are down 17% compared to 2018.
Goldman Sachs predicts that the contraction will improve slightly to 15% by year’s end. In 2020, the firm sees another 5% reduction to $675 billion. If that happens, analysts are worried that the bull market may run out of steam.
“Companies spend less cash when policy uncertainty is high. During August, global economic policy uncertainty registered the highest level in at least 20 years,” wrote Goldman’s David Kostin in a note.
“Historically, growth in aggregate S&P 500 cash spending has been weaker during periods of high policy uncertainty. The combination of an ongoing trade conflict and next year’s US presidential election will likely result in lingering uncertainty.”
And while everything that Kostin said is absolutely true, what he didn’t mention was that 2019 is still on track to be a near-record year for buybacks.
In fact, it’s the second-highest year for buybacks ever, only surpassed by 2018, when share repurchases were a “no-brainer” for cash-rich operations. In fact, in the first half of 2019, buybacks were on track to beat the 2018 numbers.
It wasn’t until early August, after a poorly-received rate cut and trade war setback, that companies truly fell off the wagon. Uncertainty rocked equities and corporations alike, causing buybacks to falter.
But still, in the grand scheme of things, we’re coming off a record year for stock repurchases. A decline was to be expected.
More importantly, it’s not something for investors to be overly worried about. Earnings, even if they decline 4.7% as predicted in Q3, could still give the market reason to continue buying. Bulls won’t turn their noses up at companies that beat analyst expectations, even if the margins of victory are slim.
So, while buybacks may decrease, that doesn’t mean we’re in trouble. Rather, it suggests that companies want to keep their “war-chests” full in the event of another trade war disappointment.
Or, worse yet, an Elizabeth Warren victory in 2020, an event that could bring about more uncertainty than anything else.