The biggest drag on S&P 500 earnings? Not the trade war

Expected 20% gains for Q2 S&P 500 earnings despite currency movements drag. 

July 16, 2018

Earnings growth for S&P 500 firms in the second quarter of 2018 is predicted to be strong. Earnings for the index are expected to grow by an average of 20 per cent while the number of firms issuing positive earnings per share guidance is above the five-year average.

Of course, no matter how bullish sentiment is, or how robust earnings reports are, there’s always something acting as a drag on earnings. According to research carried out by FactSet Insight, the most common negative impact on earnings so far in the latest quarter has been currency movements.

FactSet Insight searched for specific terms in the transcripts of conference calls for the 5 per cent of S&P 500 firms that have already reported earnings (most S&P 500 firms have yet to declare). As the graph below shows, terms related to currency fluctuations were most prevalent in discussions of negative impacts on earnings.

The US dollar has seen strong gains against other currencies this year, largely because of solid US economic growth against a backdrop of weaker global growth. A strong dollar means US exports become relatively expensive in their overseas markets.

Both tariffs and China, meanwhile, were almost absent. Only one firm, the house builder Lennar, cited tariffs, noting a ‘backdrop of serious industry headwinds of a tight labour market, elevated lumber prices and international trade tariffs’.

This is at odds with the sentiment of most investors, who have cited trade tensions as their dominant macroeconomic concern, according to Bank of America Merrill Lynch’s regular international investor survey.

With tariffs only coming into effect at the very start of July, and China’s response having been so far subdued, it was never likely that the trade war would yet make itself felt on firms’ earnings for quarter two.

However, as the dispute between the US and both China and the EU continues to escalate, firms are likely to start feeling the effect, either through higher tariffs in key export markets or through higher costs on imported components.

Many analysts remain bullish nonetheless. Goldman Sachs strategist David Kostin argued last week that the S&P 500 would rise by a further 5 per cent to 2850 by the end of the year, citing strong US growth and corporate profits alongside share buybacks.

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