Earnings deceleration worries
One of the major market worries at the core of the current market sell-off is the coming earnings deceleration. The stock market rally in 2018 has been fueled in part by the tax reform windfall. Moreover, US companies (SPY) (IVV) have initiated record levels of stock buybacks in 2018. According to Goldman Sachs (GS), US companies are poised to authorize a record $1 trillion in buybacks. Apple (AAPL) alone has authorized buybacks worth $100 billion.
The impact of these factors, however, is expected to start fading in 2019, leaving earnings more exposed to fundamental factors such as the rising US dollar (UUP), the ramping up of trade tensions, and the building of inflationary pressure.
As per the consensus compiled by Thomson Reuters, the earnings growth of the S&P 500 Index (SPY) is expected to be 10% in 2019 compared to 23% in 2018. Under such a scenario, rising interest costs could put stocks’ high equity valuations to the test.
Profit margins to decline
Higher interest rates (TLT) are expected to impact the profit margins of US companies. Trade conflicts are also threatening to increase raw materials prices. It’s now dawning on investors that the interest rate environment has shifted from being benign to being reflective of tighter liquidity. Moreover, the valuations of equities are at a level where a small spark is enough to spook investors.
Some companies have also warned that inflationary pressures are hurting them. On October 8, PPG Industries (PPG) reported that it had been witnessing higher expenses due to higher raw materials costs and rising oil prices (USO). To combat these inflationary pressures and losses from the stronger US dollar (UUP), PPG announced that it would increase prices for automotive equipment manufacturer products by 10%. The stock closed at a fall of 10% after this announcement. PPG’s case may be an example of upcoming higher inflationary pressures for other companies as well.
Investors will likely be looking for companies’ takes on their inflationary expectations going forward as the US-China trade war continues to ramp up and the greenback continues its upward march. However, as investors grow wary of rising valuations and increasing volatility, gold’s (GLD) safe-haven appeal could come to the forefront.
Read Will Equity Valuations Pass the Stress Test of Rising Bond Yields? to learn more.