US earnings preview: some red flags, but no white ones – yet

The list of risks to equity markets is a long one, but third-quarter earnings could receive a fillip.

Having now entered the final quarter of the year, attention will turn imminently to how US companies fared in the third quarter.

The bar is being set increasingly high, not least of which because the US indices have maintained their strong performances in the year to date, which could begin to stoke valuation concerns. The Dow Jones Industrial Average is up by over 15%, the S&P 500 has added 19%, while the Nasdaq has surged by nearly 21%.

It is perhaps the latter index which will receive particular attention, laden as it is with technology stocks.

The previous quarter had shown mixed fortunes for some of the technology majors, an example of which was the starkly different reactions to updates provided by Microsoft (NASDAQ:MSFT) and Netflix (NASDAQ:NFLX).

By way of reminder, Microsoft (NASDAQ:MSFT) showed that it had revived its fortunes, with its move to build on its cloud server business paying off handsomely. This well-run tech company gives investors exposure to parts of the economy and industry catalysts that are difficult to find elsewhere. For many investors it remains a must-own stock.

Netflix (NASDAQ:NFLX), on the other hand, provided disappointing subscriber growth numbers and, despite revenues and profits beating expectations, the shares were marked down sharply at the time. As such, and with the growing threat of other streaming services from the likes of The Walt Disney (NYSE:DIS), which launches its own version Disney Plus in November, Amazon Prime and also of course Apple TV+, subscriber growth will be a critical factor in establishing whether the third quarter was a successful one for Netflix.

More broadly, the earnings recession is likely to continue, with the estimated earnings decline for the S&P500 being 3.7%, which would mark a period of underperformance not seen since late 2015/early 2016. Earnings revisions and guidance have also recently been pared back, which means positive earnings surprises will be necessary from a large percentage of those companies reporting in order to maintain momentum.

There have also been some concerns that the ongoing trade spat with China is finally starting to wash through in terms of lowered revenues. Previous warnings had come from the likes of Apple (NASDAQ:AAPL), General Motors (NYSE:GM) and Ford Motor (NYSE:F), all of whom bemoaned extremely difficult trading conditions in China, and more recently the FedEx Corporation issued a gloomy update in which its management almost entirely attributed its poor performance to global macro deterioration – long since a concern for investors as tariffs between the world’s two largest economies threaten to derail economic progress globally.

Normally a move from an economy being in late-cycle to end-cycle is represented by a move towards defensive stocks and away from cyclicals – and this has been a recent trend in terms of sector movements. Clearly the recent Federal reserve rate cut was also aimed at intercepting the possibility of recession, although it remains to be seen whether the move was adequate.

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Despite these numerous challenges, the earnings season updates may have a large factor in their favour.

An important contributor to the strong performances reported in 2018 followed on from President Trump's implemented tax windfall. This in turn resulted in some relatively modest performances in the first half of this year.

However, some of those comparisons are becoming easier as they begin to fade away, such that third-quarter numbers could receive a fillip or, at the very least, mark a trough in the recent earnings cycle.

The imminent non-farm payroll numbers and future consumer spending trends will both give a broader perspective to where the US is heading.

One thing is for certain, though – the pressure is rising on companies to exhibit strong revenues and profits. October is notoriously and traditionally a bumpy month in stock market terms, so that any weakness in company numbers – perceived or actual – will be seized upon.

Watch this space.