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The third-quarter earnings season will kick off in earnest this week with the first reports expected Tuesday from big banks JPMorgan /zigman2/quotes/205971034/composite JPM -2.55% , Goldman Sachs /zigman2/quotes/209237603/composite GS -1.74% and Citibank /zigman2/quotes/207741460/composite C -2.54% , along with fellow Dow components Johnson and Johnson /zigman2/quotes/201724570/composite JNJ +1.21% and UnitedHealth Group /zigman2/quotes/210453738/composite UNH +0.29% .
It‘s a busy start — earnings season typically starts with just one or two bank reports — but expectations for the season are subdued. The continued trade tensions between the U.S. and China and a slowing global economy are already making themselves felt in economic data and company releases and economists are increasingly warning of a coming recession.
Companies with unusual fiscal years that have already reported have highlighted those issues and the dampening effect they are having on their businesses. Parcel delivery giant FedEx Corp. /zigman2/quotes/203047719/composite FDX -0.45% , for example, said the decline in earnings that it reported for the quarter to Aug. 31, was due to the uncertain and shaky backdrop. Read more about FedEx’s earnings
“Our performance continues to be negatively impacted by a weakening global macro environment driven by increasing trade tensions and policy uncertainty,” Chief Executive Frederick W. Smith said in his company’s release.
It was a similar message from chip company Micron Technology /zigman2/quotes/205710729/composite MU +3.10% when it reported fiscal fourth quarter earnings last week with Chief Executive Sanjay Mehrotra “mindful of continued near-term macroeconomic and trade uncertainties.”
The big shock was the U.S. Institute for Supply Management’s September manufacturing index that showed the biggest contraction since the end of the 2007 to 2009 recession and served as a wake-up call for anyone that doubts the China trade war is having an impact.
“Manufacturing weakness is close to dangerous levels,” said senior economist Chris Low of FTN Financial. “Historically, readings under 46 are consistent with recession. Manufacturing is a small part of the economy, but it is a vitally important one, producing income and multiplier effects, especially in the Midwest.”
That datapoint was followed by a disappointing ISM report on the services side of the economy, showing the weakest growth in September in three years.
“While Chinese tariffs are understandable, they are impacting our supply chain decisions,” one executive told ISM. “We are actively pursuing alternate sources for our China-based production. At this point, we have not passed on tariff costs to our customers, but we are evaluating all options.”
The FactSet consensus is for a third quarter of negative earnings growth, which would confirm and extend the earnings recession, which is typically recognized after two quarters of negative growth. The FactSet blended growth rate is a negative 4.77%, after an adjusted negative 0.5% in the second quarter. Energy and IT sectors are expected to be the weakest performers, followed by financials, consumer staples and consumer discretionary. The only sectors with positive growth forecasts are utilities, real estate, health care and communication services.
Here are 5 things that are expected to feature prominently this earnings season:
China trade war
Tensions with China spiraled last week amid a spat between the NBA and Chinese government over a tweet sent by Houston general manager Daryl Morey supporting the protesters in Hong Kong. The Chinese state broadcaster CCTV said it would no longer air two NBA pre-season games due to be played in China.
Then late last Monday, the U.S. government announced plans to blacklist 28 Chinese tech companies because of their alleged role in human-rights violations against the Uighur Muslim minority. The news came just ahead of the resumption of talks between U.S. and Chinese negotiators to be led by China Vice Premier Liu He that kicked off on Thursday.
Wedbush analyst Daniel Ives said tech companies, which often dictate market direction during earnings season, are facing a big challenge in the “China black cloud,” which is casting a shadow over big names, including Apple Inc. /zigman2/quotes/202934861/composite AAPL -0.10%
There’s a lot at stake.
“We view the coming weeks as either a “Fort Sumter” moment for the US/China UFC trade battle or a false alarm as the tariff can gets kicked further down the road with the pivotal $160 billion (e.g. electronics, processors, smartphones, etc.) tariff deadline looming for the tech space,” Ives wrote in a note.
President Donald Trump on Friday announced a partial trade deal — which includes Chinese purchases of U.S. agricultural products and the U.S. calling off tariff hikes that were set to take effect this week — and the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA -0.07% soared more than 300 points Friday, though many felt any boost to stocks would be fleeting given ongoing uncertainties.
“Regardless of whether the two sides can reach a short-term, narrow truce, we remain pessimistic on the U.S.-China economic relationship over the medium term,” wrote Nomura chief U.S. economist Lewis Alexander in a note to clients.
That uncertainty is expected to extend into next year, which could put a damper on corporate guidance. Alec Young, managing director of global markets research at FTSE Russel, said a trade deal that forestalls new tariffs going into effect on Oct. 15 may be perceived by investors as a positive, but it is “critical” to remember that it doesn’t mean things are getting better, only that things aren’t getting worse.
“Until we get a deal that ends existing tariffs, 2020 earnings visibility will remain murky, especially in light of the ongoing weakness in the global economic growth outlook,” Young said.
Slowing overseas economies taking a toll
It’s easy for companies to blame the trade war for their troubles, because that implies a potentially temporary effect that is out of their control. An economic slowdown driven by weakness overseas, whether it is a result of trade uncertainty or not, is something that can’t be fixed with a tweet or a trade agreement.
Investors should keep a keen eye on the geographic breakdowns of revenue or profit growth, to see the extent of international weakness, and whether that weakness has started hitting domestic results.
The overseas consumer was showing signs of hurting, as branded consumer foods company General Mills Inc. /zigman2/quotes/206659526/composite GIS +1.83% reported on Sept. 18 fiscal first-quarter North America retail sales that was roughly the same as last year, but said sales from Europe and Australia dropped 9% while Asia and Latin America sales fell 10%.
And although the macroeconomic and trade outlooks are closely connected, recent corporate commentary suggests they need not be mutually exclusive.