By Caroline Valetkevitch
NEW YORK (Reuters) - U.S. companies are more negative in their earnings outlooks than they have been in years, setting the advancing U.S. stock market up for a possible letdown as reporting season begins this week.
In an ominous sign, the ratio of negative to positive guidance from S&P 500 companies for the second quarter is at its highest level since the third quarter of 2016, when companies were just coming out of a four-quarter profit decline, according to IBES data from Refinitiv.
Negative second-quarter outlooks outnumber positive ones by 3.8 to 1, while the average ratio for the prior four quarters is 1.9 to 1.
That pessimism also is reflected in analysts' second-quarter earnings estimates, which now call for a drop of 0.4% in year over year earnings for S&P 500 companies after gradually declining for weeks, according to Refinitiv data.
With all three major U.S. stock indexes hitting records last week amid increased expectations that the Federal Reserve will cut interest rates this month, some strategists say earnings could disappoint investors unless results are much better than forecast or companies are upbeat about future prospects.
"The bar is clearly higher than it was a month ago given the market's strength," said Michael James, managing director of equity trading at Wedbush Securities in Los Angeles.
"There is a need for results to beat and guidance to be positive to continue the upward trajectory in the second half."
The earnings weakness may temper some of the enthusiasm over rates, strategists at UBS wrote in a note Friday.
"While we expect modest upside for equities in our base case, stronger equity market gains may not materialize until earnings growth picks up," they wrote.
The S&P 500 (SPX), which closed above 3,000 for the first time Friday, is now trading at 17.2 times forward earnings, up from just 14.4 on Jan. 1, which followed a sharp market selloff at the end of 2018.
The focus shifts to corporate earnings this week, when large U.S. banks, including Citigroup Inc (N:C) and JPMorgan Chase & Co (N:JPM), are set to report as well as Netflix (O:NFLX).
Since the majority of companies tend to beat estimates, actual earnings could end up in positive territory. That is what took place in the first-quarter reporting season, which was forecast to show an earnings decline but ended with growth of 1.6%, based on Refinitiv data.
The focus, instead, could be on what companies say about consumer spending, the impact of the U.S.-China trade war on corporate results and what earnings might look like in the second half of the year. Analysts are expecting profit growth of 0.3% in the third quarter and 6.8% in the fourth.
Also a factor are tough comparisons with last year, when tax cuts fuelled a 24.9% profit gain in the second quarter.
"It's not about whether a company beats or doesn't beat. It's more about the commentary inside earnings calls that speak directly to what companies are doing to address the tariffs. If companies are really struggling with it, the chance of having the tariffs go away increases," said Jamie Cox, managing partner at Harris Financial Group in Richmond, Virginia.
IMPACT OF TARIFFS
Companies have been warning about the effect of tariffs, which increase costs for U.S. companies and may force them to raise prices on their goods. [
Energy and materials are among sectors whose second-quarter estimates have come down the most in recent weeks. Earnings in the materials sector are expected to have fallen 31.4% from a year ago, while energy earnings are seen down 7%, according to Refinitiv. Technology sector earnings, meanwhile, are estimated to have fallen 7.9% in the quarter.
"As we get into the second-quarter earnings, I think reality will come home to roost that the global slowdown that we've seen and these higher input costs to the cost structure are going to weigh on margins more than (expected)," said Jeff Schulze, investment strategist at ClearBridge Investments in New York.