Strong corporate profits have been one of the primary factors driving the U.S. stock market higher, and it doesn't look like market participants see that changing soon.
According to FactSet, stock analysts appear unusually optimistic about the coming season for corporate quarterly results, as they have trimmed their profit-growth estimates by a far-smaller degree than is usual.
Per the data, analysts are forecasting earnings per share, or EPS, of $40.54 companies in the S&P 500 (.SPX). At the start of the third quarter, in July, they expected EPS of $41, representing a 1.1% decline.
It is typical that analysts will trim their forecasts going into an earnings season, and while the 1.1% dip is the most extreme negative revision in a year, it is a far narrower reduction than is typically the case.
Over the past 15 years, the average decline in earnings estimates has been 3.9%, or more than three times as extreme as the current quarter's rate. Over the past five years, as seen in the chart below, the average decline for forecasts has been 3.2%.
The first and second quarters of 2018 featured rare examples of profit estimates rising going into a quarter; however, this was almost entirely due to the late-2017 passage of the tax-cut bill, which sharply cut corporate tax rates, providing an immediate earnings boost.
Earnings estimate reductions over the third quarter occurred against a backdrop of sizable market gains. The S&P 500 rose 7.2% over the that three-month period, its biggest such advance since the fourth quarter of 2013. The Dow Jones Industrial Average (.DJI) climbed 9% in the quarter; both the S&P and the Dow posted their 11th rise of the past 12 quarters, while the Nasdaq Composite Index (.IXIC), which gained 7.1% in the quarter, posted its ninth straight quarterly advance.
"The third quarter marked the 16th time in the past 20 quarters in which the bottom-up [EPS] estimates decreased during the quarter while the value of the index increased over this same period," wrote John Butters, senior earnings analyst at FactSet.
The third-quarter earnings season will unofficially start next week, with the release of results from major financial institutions like JPMorgan Chase & Co. (JPM).
While the smaller-than-average reduction of earnings expectations represents a high level of optimism over the coming season, there is also a reason to be cautious. According to FactSet, the number of companies warning about their earnings, compared with the number giving positive outlooks, is unusually high. That suggests a murkier picture for profits at a time when investors are both worried about valuations and concerned about the impact tariffs could have on the economy.
So far, 98 components of the S&P 500 have issued earnings outlooks for the quarter ahead. Of these, a sharp majority — 76%, or 74 of the 98 — gave negative guidance. This is above both the five-year average of 71%, and it is also on track to be the highest quarterly percentage since the first quarter of 2016.