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Are profits close to peaking?

Here's the good news: Corporate profits for the third quarter should be really strong. Now for some bad news...

Posted: Oct. 9, 2018 6:18 PM
Updated: Oct. 9, 2018 6:18 PM

Here's the good news: Corporate profits for the third quarter should be really strong. Now for some bad news: It might be all downhill from here.

Analysts are predicting that earnings for the S&P 500 will rise nearly 20% from a year ago. We'll get a better sense of just how well big US companies are doing later this week when Delta (DAL), Walgreens (WBA), JPMorgan Chase (JPM), Citigroup (C) and Wells Fargo (WFC) report their results and give outlooks for the remainder of the year.

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Investors will be particularly attuned to companies' forecasts. According to estimates from FactSet Research, companies should still post solid earnings for the fourth quarter. Analysts are projecting profit growth of more than 17% from a year ago.

But the combination of rising bond yields, trade tension with China and tougher comparisons to this year could mean that earnings growth in 2019 will slow dramatically. Earnings are expected to grow just a little more than 7% in the first and second quarters of 2019.

Trade tiff with China could hurt profits in 2019

Consumer companies in particular look vulnerable.

Earnings estimates have fallen for struggling Victoria's Secret owner L Brands (LB), Lowe's (LOW), General Motors (GM), Ford (F), tobacco giant Philip Morris (PM) and meat processor Tyson Foods (TSN), noted John Butters, senior analyst with FactSet Research, in a recent report.

That's why investors will have such a focus on companies' guidance as well, in light of the waning benefit from lower corporate tax rates and the potential for a stronger dollar eating into international sales and profits, said Lindsey Bell, investment strategist with CFRA, in a report.

More tariffs kicking in on Chinese goods also could boost on profits next year. Worries about a trade war getting even nastier could lead companies to give ultra-conservative outlooks. Bell expects tariffs will be the most highly discussed topic on upcoming earnings calls.

"Corporate management teams have no incentive to be overly optimistic given the current tariff situation," Bell said.

Still, some analysts think the tariff gloom and doom is overdone. Companies may be able to weather the trade war in the future as they have in the past.

"We think tough tariff talk is more politics than economics and that investors are overestimating the negative side effects for financial markets," noted Jeffrey Cleveland, chief economist of Payden & Rygel, in a report.

Cleveland conceded the global economy may be slowing a bit but it is still expected to keep growing. And he added that investors shouldn't get too worked up about rising bond yields yet. He does not think they will move high enough to slow profit growth.

"Do higher rates spell trouble for markets? Not in our view. Rates are 'rising for the right reasons' (a strong economy). Good economic growth is great for stocks," he wrote. "This economic cycle is not yet nearing its end."

That may be true. But investors will feel a lot better if corporate leaders take a more upbeat tone when they report their results. If they don't, then expect concerns about this latest batch of earnings being as good as it gets to come back with a vengeance.

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