Positive Outlook for Economy, Trade Deal Should Be Enough to Overcome Lower Profit Expectations

This week marks the start of first-quarter earnings season with large financial services firms, including J.P. Morgan Chase, Well Fargo and First Republic Bank, reporting results on Friday. Before you get too excited, keep in mind that analysts are expecting the worst earnings season in nearly three years. However, some stock strategists believe investors should be able to look beyond reports of declining profits because the data is stale, and investors are currently locked in on the slowly progressing trade talks between the United States and China.

Last week, stocks chugged along with the major indexes posting nearly 2% gains across the board. Furthermore, the benchmark S&P 500 Index is just about 1.6% from its all-time high of 2940, reached in late September.

Recent U.S. economic reports reassured investors that they should expect moderate growth going forward. The economic data also dispelled any thoughts of a recession. However, once again the data was dated and the stock market is forward looking. Therefore, as trade talks between the two economic powerhouses continue to progress, investors are already pricing in a trade deal that could end punitive tariffs and boost future earnings growth. This should be enough to continue to drive the major equity indexes higher.

First Quarter Profits Expected to Decline

According to Refinitiv, investors should expect a 2.2% decline in first-quarter profits for the S&P 500 companies, “but those lower results are expected to be the trough.”

“Earnings growth is projected to rebound to 2.8% in the second quarter and by as much as 9% in the fourth quarter. The first-quarter decline would be the first negative earnings period since the second quarter of 2016.”

However, if investors are able to ride out last quarter’s weaker results, they could be rewarded later in the year. “The second, third and fourth quarter will show a rebound. That’s supportive of higher equity prices,” said Ed Keon, chief investment strategist at QMA. “I was thinking I’d like to see a record for the whole year, and it looks like we might do better than that.”

There is Light at the End of the Tunnel

Don’t get me wrong, there are risks at this time and earnings season seems to always contain a few surprises, but good and bad. However, with some companies lowering guidance last quarter, any weakness in earnings could easily be absorbed.

The primary risks at this time are whether the U.S.-China trade deal will be reached in a timely manner, and whether China’s economy is really bottoming in the wake of last weekend’s surprise recovery in manufacturing PMI. Furthermore, a bullish bet will actually be a wager on the success of China’s stimulus program and whether its growth will spread to other countries.

Conditions are Positive

With Friday’s respectable payroll number, the dampening of recession concerns and an imminent U.S.-China trade deal, fewer bad corporate earnings reports or positive economic reports could all be catalysts to drive stocks back to their all-time highs over the near-term.