Falling Earnings Growth Foretells Crash Could Be Ahead
The odds of a stock market crash continue to stack higher. If you own stocks and have done well, it may be time to pause and reflect.
You see, future earnings matter a lot. They are hands down one of the biggest factors that drive the market. If earnings are expected to increase, investors get excited and we see a rally. If earnings are expected to drop, nervousness kicks in and a stock market crash follows.
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Over the past few quarters, earnings were getting better. Analysts expected stellar earnings as a result. To give you some perspective, as of this writing, 91% of all S&P 500 companies have reported their financial results for the second quarter of 2018, and the earnings growth rate is about 24.6%.
If that is the actual number once all the companies have reported, it would be the fastest growth in earnings since the third quarter of 2010.
Go back a few more quarters and the earnings growth rate was similar. And because of that, we saw a rally on the key stock indices.
Negative Guidance Outweighs the Positive
Don’t forget that the stock market is forward-looking. Past earnings matter, but more important is what’s ahead. After all, solid earnings growth may be a thing of the past.
As it stands, for the third quarter of 2018, things look shaky, to say the least. Analysts are turning slightly pessimistic with their estimates and are expecting S&P 500 companies to report earnings growth of 20.3% for the quarter.
Companies also don’t look very optimistic. So far, 55 companies on the S&P 500 have issued negative guidance for their third-quarter 2018 financial results. That means that for every one positive guidance, there is 2.89 negative guidance. That is not good. (Source: “Earnings Insight,” FactSet Research Systems Inc., August 10, 2018.)
If we assume analysts are right about the 20.3% earnings growth rate in the third quarter of 2018, it would be slower than the prior quarter. And in the fourth quarter, they are expecting S&P 500 companies to report earnings growth of 17.6%.
For 2019, the earnings growth rate is expected to tumble. Analysts anticipate S&P 500 companies reporting earnings growth of 7.3% in the first quarter of the year and 7.8% in the second.
Keep in mind that such estimates tend to be very optimistic, getting more negative as additional information becomes available. That means the growth rates currently expected could end up being much lower.
Stock Market Outlook: Underperformance and Sell-Off in Coming Quarters
With all this in mind, ask yourself: if the earnings growth rate is falling, what will happen to the stock market?
Let me reiterate that the stock market’s direction depends a lot on future earnings. As such, it would be shocking to see key stock indices underperform and experience an outright sell-off in the coming quarters.
Over the past few years, investors have become too used to the stock market soaring. If the market underperforms for a few quarters, it could take a toll on these complacent investors. And if they all suddenly panic all at once, we could have a stock market crash at hand.
