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Nov. 2, 2019, 8:31 a.m. EDT

How the frugality of U.S. corporations saved third-quarter results from the abyss

Roughly 70% of S&P 500 companies have reported third-quarter earnings

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By Chris Matthews, MarketWatch


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Thrifty third quarter?

Third-quarter earnings season was supposed to be a tough stretch for U.S. companies, and while it still appears that earnings-per-share, or EPS, for America’s largest public companies will decline year-over-year during the three-month period, reported results are coming in much better than feared.

Through a combination of expectations management, share buybacks and aggressive cost cutting, S&P 500 index /zigman2/quotes/210599714/realtime SPX +0.91%  companies have largely beaten analyst expectations and steadily trimmed the margin by which data providers see earnings contracting in the third quarter, analysts and investors tell MarketWatch.

Of the 356 companies in the S&P 500 that have reported third-quarter earnings thus far, 75.8% have reported EPS that exceeded analysts’ estimates, according to data from Refinitiv, above the average 65% beat rate since 1994, putting the index on pace for an overall decline in earnings of 0.8%, up from a predicted 2.2% contraction on Oct. 1.

“It’s been a pretty good reporting season so far, given expectations going in,” Lindsey Bell, chief investment strategist at Ally Bank told MarketWatch. “We are still looking at a decline in earnings, but much better than feared,” she said.

‘If there’s one thing to know about this earnings season, it’s that the numbers aren’t as bad as we feared because companies are cutting costs in creative ways.’

Lori Calvasina, head of U.S. equity strategy at RBC


The analyst, who joined Ally Bank from CFRA Research in September, said the most encouraging aspect of the data released so far is that “weakness has been cordoned off to the industrials, materials and energy sectors,” which have long been thought to be negatively affected by trade uncertainty, while other sectors of the economy have remained immune.

Indeed, the energy sector — buffeted by the roughly 13% decline in the price of oil during the past 12 months — has been a major drag on S&P 500 earnings, on pace to notch a 35.5% decline in profits, according to Refinitiv estimates, while the materials sector is on trend for 10.2% decline. Excluding the energy sector, S&P 500 earnings would be seeing earnings growth of 1.6%.

Corporate stock buybacks continue to support EPS growth, though not as robustly as last year, with companies in the index on pace to authorize $171 billion in share repurchases in the third quarter, 4.3% below the same period last year. Lori Calvasina, head of U.S. equity strategy at RBC estimated that share counts will decline by 1.6% in the third quarter of this year, down from 2% in the second quarter and 2.2% in the first.

Calvasina told MarketWatch that the most salient trend in corporate earnings calls have been a greater emphasis on cost-cutting programs. “Companies have just gotten really good at managing their cost structures,” she said.

However, this hasn’t taken the form of widespread job cuts. “If there’s one thing to know about this earnings season, it’s that the numbers aren’t as bad as we feared because companies are cutting costs in creative ways,” the RBC strategist said. “And they’re managing to cut costs without cutting employment.”

On a more concerning side, there has been growing discussion of trade tensions on management calls. She said that a little less than half of companies reporting so far have discussed tariffs and trade on their earnings calls, up from last year. “Tariffs and trade are clearly a problem,” she said. “Companies deserve accolades for responding well, but it’s still not clear whether we’ve reached a turning point or a tipping point” on the trade issue.

Aaron Clark, portfolio manager at investment management company GW&K Investment Management, said the emphasis of cost cutting over investing is unsustainable. “Trade uncertainty has been weighing on capex, and its unclear what is going to reaccelerate the economy and move companies away from just protecting their balance sheet,” he said. Even with hopes rising that the U.S. and China will soon reach some agreement on trade, it isn’t clear the deal will be comprehensive enough to bring true certainty on trade policy, he said.

Even with lingering trade uncertainty, analysts predict that the third quarter will mark a trough in corporate earnings growth.

FactSet has labeled the current stretch an earnings recession, with slight EPS declines of 0.2% and 0.1% for the S&P 500 in the first quarter and second quarter of this year, respectively, while forecasting that the third quarter will see earnings fall 2.8%. It projects that earnings will grow by 0.7% in the fourth quarter.

Refinitiv, on the other hand, reported overall earnings growth in the first and second quarters before showing projections for a 0.8% loss this quarter and a 1.1% growth rate in the fourth quarter.

Investors, meanwhile are cheering results and against the backdrop of easy-money Federal Reserve. and subsiding tariff tensions between the U.S. and China. The S&P 500 touched its third record close of the week on Friday and the Nasdaq Composite Index /zigman2/quotes/210598365/realtime COMP +1.00% jumped 94.04 points, or 1.1%, to notch its first all-time high since July 26, while the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +1.22% closed within 12 points of its July 15 record.

Read: Dow and S&P 500 are set to rise at least another 5% in the next 2 months — if this pattern holds

/zigman2/quotes/210599714/realtime
US : S&P US
3,145.91
+28.48 +0.91%
Volume: 1.70B
Dec. 6, 2019 5:07p
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/zigman2/quotes/210598365/realtime
US : U.S.: Nasdaq
8,656.53
+85.83 +1.00%
Volume: 1.87M
Dec. 6, 2019 5:16p
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/zigman2/quotes/210598065/realtime
US : Dow Jones Global
28,015.06
+337.27 +1.22%
Volume: 224.83M
Dec. 6, 2019 5:07p
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