As Q4 earnings start to roll out, the best scenario is that companies acknowledge natural cyclical softening within the context of economic expansion and explain tailwinds in specific sectors or industries. Investors are likely to react positively. Should companies use expected volatility to dump all problems and provide gloomy outlooks, this earnings season will be difficult.
Companies will be cautious, but that doesn’t mean the end of the renascent equity rally. US homebuilder Lennar reported last week that it would not provide guidance for 2019, citing uncertainty. The honestly was embraced by the market and instead of falling rose over 8% that day. Apple and its supply chain have already taken a hit. When Apple officially cut guidance for iPhone production, stock prices of several suppliers and those valuations moved relatively little on the report. Companies involved in delivering chips to consumer electronics, cars, and communications equipment are trading at multiples of 10x this year’s earnings, indicating the market sees no growth onward.
While plenty of analysts forecast a 2019 recession, economic data so far is positive. Investors are concerned over trade tensions, pace of normalizations and softer growth (now driven by US government’s partial shutdown). But there is plenty to be optimistic about: strength of US growth and rising wages provide a solid backdrop for earnings. With many stocks trading below 10x 2019 earnings, and the S&P 500 averaging just over 14x, value investors have a wide selection of high-quality stocks.
