S&P 500 Faces Headwinds But May Avoid Profit Recession: Oxford Economics

The S&P 500 companies may escape a profit recession in 2019 as the resilience in the U.S. economy, easing trade tensions and an expected weakness in the U.S. dollar improve confidence, Lydia Boussour, senior U.S. economist at Oxford Economics, said.

The S&P 500 earnings is likely to see a profit slowdown -- first time in nearly three years -- as revenues take a beating from slower growth, and higher input costs and cooler productivity growth bite, Boussour said in a note.

The specter of a profit recession is rising with fears that corporate earnings could see back-to-back declines following stellar profit growth in 2018, she said. The latest Factset estimates point to a 4.3 percent earnings decline in Q1 -- which would mark the first negative performance in nearly three years.

Federal corporate tax rate reduction from 35 percent to 21 percent under the 2017 Tax Cuts and Job Act boosted after-tax corporate profits last year, marking their fastest pace since 2010. Before-tax profits also had their best year since 2012, “propelled by faster domestic activity -- with GDP growth scoring its best performance since 2015 -- and a synchronized global economic upswing into early 2018,” Boussour said.

But going forward, she expects companies’ margins and sales to face growth headwinds. “We expect higher labor costs to squeeze profit margins in coming quarters as productivity growth loses some steam and companies fail to gain significant pricing power.”

Slower GDP is expected to weigh on sales growth this year, and slowing global growth poses a further downside risk to the revenue growth, Boussour wrote. “A downside surprise in GDP growth or an acute margin contraction could push corporate profits growth into negative territory,” she added.

She expects S&P 500 revenue growth to settle in the low single digits from the 9 percent year-on-year average pace in 2018.

GDP growth is expected to slow from 3 percent to 2 percent by the fourth quarter of 2019 due to dissipating fiscal stimulus, mildly tighter financial conditions, and slower global growth. Nominal GDP growth is likely to dip from 5.2 percent year-on-year to 3.7 percent year-on-year in Q4 2019.

Global growth has weakened significantly -- down from a peak of 3.4 percent year-on-year in early 2018 to 2.7 percent year-on-year estimated in Q1 2019.

Lingering trade tensions and a strong dollar -- which dampens export volumes and lowers the value of overseas profits -- have weighed on corporate profits. But Boussour expects stabilization in global growth to put some downward pressure on the dollar, which will, in turn, help the value of overseas profits.

“Overall, we believe that the rebound in U.S. growth from the first quarter soft patch and the tentative stabilization in global growth should prevent a sharp decline in revenues,” Boussour said.

“Resilient US economic activity and the emergence of green shoots in Europe and China – helped by a global dovish shift from central banks – comfort our expectations that global growth will stabilize in H2 and point to a 2019 profit slowdown rather than a profound correction,” she added.

She said in the event of a profit recession, “the risk would be that a broad-based and prolonged profit downturn would lead to slower hiring and business investment amid cooling economic momentum.”

The effects could be intensified by potential stock market turbulence and a decline in business confidence, she added.