| BY KYRA MYERS | STOCK MARKET NEWS TODAY |
Dozens of companies have slashed their profit forecasts for the first quarter. Walgreens Boots Alliance Inc. last week became the latest big company to cut its full-year profit forecast as a result of challenging market conditions, joining corporate powers such as Apple Inc., FedEx Corp. and 3M Co.
As earnings season kicks off in earnest this week, the expected slide in profits will come up against an accommodative Federal Reserve that has fueled a sharp bounceback in stocks this year. The central bank’s decision to put interest-rate increases on pause for the rest of 2019 has helped push the S&P 500 up more than 15% since January—its best start to a year since 1998. That run-up has put it within striking distance of the high it reached last September, just before markets were routed as the year ended.
Now the question is whether the central bank’s move to loosen monetary policy will continue to boost the stock market through its first pullback in earnings in nearly three years.
“Margin degradation could be more perverse than what we’ve seen the last couple of years,” said Mike Wilson, chief equity strategist at Morgan Stanley , referring to the rising costs facing companies in the first quarter, from a stronger dollar to hiring workers. “Investors are rightly encouraged by the Fed’s reactions, but the Fed easing on policy isn’t going to alleviate margin pressures.”
Analysts project S&P 500 profits in the first quarter will contract 4.2% from a year earlier, according to FactSet, followed by flat growth in the second quarter. That puts the broad index at risk of entering its first earnings recession—marked by at least two or more consecutive quarters of negative earnings growth—since 2016.
Companies that miss earnings estimates could respond by cutting spending on capital improvements and labor, further strangling economic growth and reigniting a stock-market selloff, Mr. Wilson warned, adding that earnings misses tend to force companies to rethink their priorities.
Part of the profit pain for companies is due to the high bar many set during last year’s tax-cut-fueled earnings boom, making year-over-year comparisons hard to meet without another economic stimulus. S&P 500 companies grew profits 20% in 2018, one of the best growth rates since the financial crisis, according to FactSet. Analysts see profits growing just 3.7%
But year-over-year comparisons are expected to ease up for companies as they progress past the first quarter, said Lew Piantedosi, who leads Eaton Vance ’s growth-stocks team. The dollar is stronger at this point than it was last year, putting a strain on multinationals, while lower oil prices are contributing to the downward revisions among energy stocks.
There is also the potential for the Fed to cut rates, Mr. Piantedosi added, a move that could further entice investors to buy stocks over less risky investments such as bonds. Futures markets are increasingly pricing in a Fed rate cut by the year’s end, a move President Trump endorsed Friday despite the fact that the central bank’s policy decisions are traditionally immune from political interference.
“Everything always starts with the Fed,” Mr. Piantedosi said. Still, Mr. Piantedosi and others say they plan to closely watch what companies say during the first-quarter earnings reporting season, which begins later this week with results from JPMorgan Chase & Co. and Wells Fargo & Co.
The pullback in first-quarter profits across the broad S&P 500 will likely surprise few investors since companies had been telegraphing their economic challenges to the market since January, but how they forecast their performance in subsequent quarters could spark a new bout of volatility, said Russ Koesterich, a portfolio manager at BlackRock Inc. ’s global allocation team.
Investors will have to reconcile any warnings with valuations that have crept higher in recent months. S&P 500 companies are trading at 16.7 times their future earnings, the same level the broad index traded at in early October, just before the start of the fourth-quarter selloff, and a slowdown in earnings could make further multiple expansion harder to justify.
Money managers, including Morgan Stanley and Goldman Sachs Group Inc., have been pushing clients to consider alternatives in the stock market, specifically companies that have fairly high and stable profit margins, as well as an ability to boost prices. Procter & Gamble Co. , which is up 13% this year, is among Morgan Stanley’s picks, while Goldman has recommended shares of software maker Adobe Inc. and retailer AutoZone Inc.
“Companies are finding themselves more pressured on margins. Even if the economy chugs along and the Fed remains on hold, a greater-than-expected deceleration in earnings wouldn’t bode well for stocks,” said Mr. Koesterich. “The question is whether the market has discounted enough the impact of slowing growth and some margin pressure on earnings.”