Corporate profits

The next victim of the trade war: corporate profits


President Trump began using tariffs as a tool in trade negotiations in January 2018, and while these new trade barriers have been the root of stock market volatility since, it has taken some effort. to see their impact on the economy or the results of companies. .

The US economy grew at the fastest pace in four years in 2018, while earnings growth for companies in the S&P 500 SPX Index,
-0.32%
was 22.7%, the best rate since the financial crisis. Still, the impact on corporate earnings threatens to worsen as the trade war escalates, analysts and strategists have said.

“Over the past two months we’ve seen significant negative revisions” to earnings estimates for the second quarter of 2019, Alec Young, managing director of global market research at FTSE Russell, told MarketWatch of the concerns. business being a major factor.

The Trump administration first instituted broad tariffs on goods imported from China in June, and in September it expanded those tariffs to include a 10% levy on $ 200 billion in annual imports. Earlier in May, the president raised those tariffs to 25%, while instituting restrictions on the buying or selling of goods to private Chinese telecommunications giant Huawei Technologies Co. Ltd.

“There is a positive correlation between the global and cyclical nature of an industry and the magnitude of the revisions we get,” Young added.

As analyst estimates earnings growth at Russell 1000 RUI,
-0.47%
companies in 2019 remained roughly flat at 3%, many individual sectors saw extreme revisions to second quarter earnings estimates.

Since April 1, projected profits in the materials sector have fallen from a profit decline of 5.5% to a decline of 18.4%, while companies in the information technology sector are expected to experience a decline 7.8%, larger than the 5.8% drop forecast two months ago. Industrial companies have also undergone severe revisions – analysts forecast growth of 7.6%; they now expect profits to be stable, according to Young.

Michael Arone, chief market strategist at State Street Global Advisors, pointed out that the economic impact of tariffs has so far been small, with the current tariff regime reducing US economic growth by about 0.1% each quarter. Although this reduced growth worsens over time, he said the impact on the economy so far has been “tolerable”.

The effect on the S&P 500 companies, however, will be more profound, as many of the large companies in the index originate from or derive a significant portion of their income from China. “We see that earnings estimates tend to fall overall for the second quarter,” Arone said, adding that investors have been quicker to punish companies with a significant footprint in China than analysts.

“Analysts remain optimistic that there will be a trade deal in 2019 at some point,” he said. “The risk is that it doesn’t happen.

Since Trump announced his intention to increase tariffs on May 5, the S&P 500 and the Dow Jones Industrial Average DJIA,
+ 0.05%
each lost 5.8%, while 2019 estimates for S&P 500 earnings growth fell only 0.2 percentage points, from 3.4% to 3.2%, according to FactSet.

David Kostin, chief US equities strategist for Goldman Sachs, said in a research note Wednesday that the Trump administration’s decision to increase tariffs on $ 200 billion in annual imports from China of 10 to 25% will reduce the S&P 500 earnings in 2019 to $ 165 per share. , down from $ 168.

The most important effect of the new short-term trade restrictions, however, could be the indirect channel of business confidence. Amanda Agati, co-chief investment strategist at PNC Financial Services Group, told MarketWatch that “trade tensions have already been at the fore for over a year, so we believe companies should be better positioned” in terms of adjustment of their supply chains to minimize the impact of tariffs on profits.

That said, the new tariffs and the threat of further escalation appear to be weighing on business confidence, with the latest reading of the Conference Board CEO Confidence Measure showing that executives are, on the whole, pessimistic about current economic conditions. This could contribute to the recent weakness in business investment, which could reduce profit growth in the years to come, Agati said.

Indeed, what is of most concern is the growing likelihood that the current trade conflict will metastasize from a disagreement over single-front economic policies into a larger geopolitical battle between the United States and China.

“A big wild card is Huawei,” Agati said. She said the administration’s decision to ban trading with the company appears to be a negotiating tactic, given that it has issued fairly broad temporary exemptions to the policy.

“If a total ban were to go into effect, it would change the narrative quite dramatically and skew things down,” Agati said, as there is apparently no end to the ways the federal government could force a disintegration. from the United States and China. economic relationship, if national security so requires. “The question is where is the end of the game,” Agati said. “Where do you stop once you start banning certain businesses? “