The earnings picture for 2019 is showing more signs of deterioration

Updated Mon, Jun 24, 2019, 9:03 AM

For the third quarter of 2019, Wall Street is expecting a 0.3% year-over-year decline in earnings for S&P 500 companies, compared to their previous forecast of 0.2% growth, according to FactSet. This comes on top of a 2.6% projected decline in second quarter earnings and the 0.3% decline seen in the first quarter of 2019. An earnings recession, defined as two back-to-back quarters of negative earnings growth, is looking more likely. If this occurs, it would be the first earnings recession since 2016.

A trader works on the floor during the Slack Technologies Inc. IPO at the New York Stock Exchange (NYSE) in New York, U.S. June 20, 2019. REUTERS/Brendan McDermid

Even with these weaker forecasts, the S&P 500 (^GSPC) is trading at record highs, as expectations of a more dovish Federal Reserve reached fever pitch.

Still, corporate earnings traditionally drive the stock market.

“Sustainability of earnings matters a lot and I believe that is directly correlated to the trade issues,” David Bahnsen, founder and CIO of The Bahnsen Group, told Yahoo Finance. “The Fed can impact earnings via holding corporate borrowing rates down (the reversal of which is what the market revolted against in Q4 2018), but primarily the Fed impacts the market multiple. Trade, however, impacts organic earnings growth. All of these things are correlated.”

Tariffs and earnings expectations

Trade worries escalated throughout the month of May, with President Trump weighing an increase on existing tariffs against China and imposing new tariffs on Mexico, which were eventually called off.

Bahnsen’s thesis of trade uncertainty affecting earnings expectations can be seen in the data.

The aforementioned forecasted third quarter earnings decline is only being driven by two sectors: information technology and energy, with a 9% and 13% projected decline, respectively. Technology is the sector that gets the highest percentage of its revenue from overseas, while energy is the fourth most exposed sector to overseas revenue, according to FactSet. Sectors that rely on overseas revenue can be more affected by tariffs. That’s why tech stocks tend to selloff following negative trade headlines.

The key part of this analysis is “forecast.” The actual earnings numbers can come in much different.

At the start of the first quarter earnings reporting season on March 31, Wall Street was expecting a 4% year-over-year fall in earnings growth, according to FactSet. The actual drop ended up being only 0.3%.

“The market expectations proved wrong for Q1 — very wrong,” Bahnsen noted.

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Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.

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