A Cautiously Optimistic Outlook for U.S. Earnings

LIghthouse

The U.S. profits recession probably didn’t end last quarter, with S&P 500 earnings likely to post a fourth consecutive quarterly decline. We see company earnings improving in the second half, but the rebound may be smaller than many expect. This week’s chart helps explain why.

A second-half U.S. earnings recovery will be underpinned by three key factors, we believe: a slowdown in the U.S. dollar’s rise, stabilizing energy prices and solid consumption growth driven by rising wages. Yet a slowdown in capital expenditures (capex) may offset these positives. The amount companies plan to spend on capex in the coming 12 months has dropped to the lowest level since 2010, as the chart above shows.

006920A_BII_chart_web_V2

The energy sector has driven much of the recent capex weakness, and capex is a less important barometer of sentiment in service sectors and asset-lite businesses. But we believe many companies may be reluctant to invest in an uncertain political climate marked by an impending Brexit and the upcoming U.S. presidential election. As second-quarter earnings season moves into full swing, we will be paying close attention to any signs of reduced investment appetite in corporate guidance.

We will also be focused on earnings quality. The exclusion of asset write-downs in the energy and materials sectors and the use of aggressive accounting practices have inflated pro-forma earnings. We are watching for improvements in sales growth and cost controls — as well as the strength of demand that multinationals report seeing out of China and other emerging markets (EMs).

We see Brexit-related uncertainties weighing the most on already-depressed European earnings. Japanese and EM earnings estimates are also on a downswing. Bottom line: U.S. equities are the least dirty shirt of global equity markets, although high valuations keep our return expectations in check. We favor quality stocks and dividend growers. Read more market insights in my Weekly Commentary.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog.

Kate Moore, BlackRock’s chief equity strategist, contributed to this post.

 

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