Are We About To Enter An 'Earnings Recession'?

by: Louis Navellier

The bulk of Q4 earnings have been announced and the average stock has posted a 5.7% sales increase and a 14.3% earnings increase – the 5th straight quarter of double-digit earnings growth.

Despite that great news, the S&P fell 2.16% last week as CNBC kept warning about a coming “earnings recession”.

However, 2018 was a year of 24% earnings growth and a 6% decline in the S&P 500, so a year of flat earnings may not impact the market that much.

The bulk of fourth-quarter earnings have been announced and the average stock has posted a 5.7% sales increase and a 14.3% earnings increase – the fifth straight quarter of double-digit earnings growth.

Despite that great news, the S&P fell 2.16% last week as CNBC kept warning about a coming “earnings recession.” They are referring to the analyst community’s forecast that first-quarter 2019 S&P 500 earnings could decline 2.9%, due largely to more difficult year-over-year comparisons. Specifically, FactSet is expecting that only four of the 11 S&P sectors will post positive earnings growth in the first quarter, namely Healthcare (up 5.4%), Utilities (+3.9%), Industrials (+3.1%), and Real Estate (+1.9%).

However, 2018 was a year of 24% earnings growth and a 6% decline in the S&P 500, so a year of flat earnings may not impact the market that much. Maybe the late 2018 correction reflected the anticipated drop in 2019 earnings growth, so the market may now look forward to 2020 earnings more than 2019.

Can We Sustain 3% GDP Growth in 2019?

On February 28, the Commerce Department announced that fourth-quarter GDP grew at a 2.6% annual rate, bringing the full-year growth rate up to 2.9%, just shy of President Trump’s stated goal of 3%.

However, that figure could be revised lower in the next iteration, since the Commerce Department announced last Wednesday that the U.S. trade deficit soared 18.8% in December to $59.8 billion, its highest monthly level in a decade. U.S. exports declined 1.9% to $205.1 billion, while imports rose 2.1% to $264.9 billion. I should add that some economists believe that imports soared in December because businesses were trying to build their inventories up, just in case tariffs were increased in early 2019.

On top of that, first-quarter GDP growth is set to take a hit. Severe winter weather has impacted the U.S. so much that it will impact GDP. The Atlanta Fed is now expecting just 0.5% annual GDP growth for the first quarter, which is not too bad, since first-quarter GDP is often negative due to severe winter weather.

However, there is good reason to think the economy will pick up in the middle quarters of the year, as it did last year, especially if we see a favorable resolution to the U.S./China trade spat. After the latest talks, the U.S. is prepared to remove tariffs on $200 billion of Chinese goods in exchange for China lowering its tariffs on U.S. auto, chemical, farm, and other products. Furthermore, China would buy $18 billion in natural gas from Cheniere Energy (NYSEMKT:LNG) and would not file a formal complaint with the World Trade Organization (WTO) concerning the recent U.S. tariffs. Since China’s exports plunged 20.7% in February (vs. a year ago), I suspect China wants to boost its exports by ending the U.S. tariffs as soon as possible.

Navellier & Associates does own Cheniere Energy in managed accounts but does not own Cheniere Energy in our sub-advised mutual fund. Louis Navellier and his family do not own Cheniere Energy in personal accounts.

There was a lot of positive economic news released last week, all pointing to future GDP growth.

  • On Tuesday, the Institute of Supply Management (ISM) announced that its non-manufacturing (service) index surged to 59.7 in February, up from 56.7 in January and well above economists’ consensus estimate of 57.4. The new orders and business activity components were especially robust at 65.2 and 64.7, respectively. Additionally, all 18 ISM components rose in February, a rare event.
  • Also on Tuesday, the Commerce Department reported that new home sales rose 3.7% in December to an annual rate of 621,000. The median sales price was $318,600, 7% lower than a year ago.
  • On Friday, the Commerce Department announced that new housing starts surged 18.6% in January to an annual pace of 1.23 million. Residential building permits rose at a much more modest 1.4% to a 1.345 million annual pace. Both came in at a much higher pace than expected, since economists were expecting new housing starts to rise 9.5% and building permits to decline 2.7%.

The ADP and payroll jobs report also came out last week, but I won’t get into the details here, since the revisions are typically large in future months, and the partial government shutdown skewed the way the statistics were tabulated this time. For instance, the January ADP private payroll report was revised up to an impressive 300,000, from 213,000 previously estimated. However, I will cite the good news that average wages per hour rose 3.4% to $27.66 in the last 12 months. This wage growth has not been inflationary, since the U.S economy continues to boost its productivity. Specifically, U.S. productivity in the fourth quarter rose at an annual rate of 1.9% and in the past 12 months grew at a robust 2.2% pace.

In Contrast, Europe is Struggling

The big surprise last week was that on Thursday, the European Central Bank (ECB) stunned observers by unveiling plans to stimulate Eurozone economic growth. This was a major policy reversal, since not only did the ECB say that they would hold interest rates steady for the remainder of 2019, but they also announced low-cost loans to banks to help shore up their capital base. The first batch of ECB loans will be offered in September with a two-year maturity. The ECB slashed its 2018 GDP forecast to 1.1%, down from 1.7% in December. ECB President Mario Draghi said, “The persistence of uncertainties related to geopolitical factors, the threat of protectionism and vulnerabilities in emerging markets appears to be leaving marks on economic sentiment.” Draghi said the probability of a Eurozone recession was “very low,” but uncertainty surrounding Brexit on March 29 is a wild card that must be taken into consideration.

On Friday, it was announced that German factory orders declined 2.6% in January, substantially below economists’ consensus estimate of a 0.5% increase and the biggest monthly decline since last June. Orders outside the Eurozone were especially weak, which is consistent with China’s plunging exports. Domestic orders also fell, so if Germany follows Italy into a recession, the ECB will have to get much more aggressive, especially since Brexit is causing so much uncertainty.

By contrast, the U.S. remains in a “Goldilocks” environment with accommodative central banks and moderating interest rates due to slower global growth and serious Brexit concerns. There is no doubt that there is a global economic slowdown underway due to plunging Chinese exports and German factory orders, so the ECB has decided to provide new stimulus to try to avoid a Eurozone recession.

The key for investors in the upcoming months will be to concentrate on dividend growth stocks as well as conservative growth stocks that are forecasted to post strong earnings momentum in a decelerating earnings environment. My A-rated (Strong Buy) & B-rated (Buy) stocks in both Dividend Grader and Stock Grader are expected to remain an oasis for investors and should continue to benefit from persistent institutional buying pressure in an increasingly narrow stock market environment.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.