U.S. Equity Outlook: The Battle Royale Continues
This earnings season may be the most important one in years
We are listening for any evidence of fundamental deterioration
Our focus on high-quality companies should serve us well
After undergoing a “healthy correction” in December, we believe U.S. equity markets are undergoing a multi-month corrective process driven by trade tensions, the path of Fed hikes, and the outlook for earnings. We have taken a conservative stance toward earnings growth in 2019 and have held a below consensus, base case forecast of 5%. This earnings season is perhaps the most important one in years.
Key things we are listening for to see if there is risk to our expectations include:
Any evidence of fundamental deterioration. While economic activity is slowing both domestically and internationally, it is still growing. Revenue growth generally produces positive operating leverage, which should also be helped by lower input prices as many commodity prices have declined. Rising interest rates are also a modest positive as the balance sheet of the S&P 500 has more cash than debt. Increased labor costs are a potential headwind to margins. Corporation cash flows should remain solid. Net, we believe reported results will be choppy, but overall fine.
The tone and specifics of forward guidance from companies. Results of the positive stimulus of tax cuts are beginning to fade, and concerns over the implications of trade tensions, Brexit, and Fed policy are impacting business decisions as evident by declining PMIs and declining global trade. Given this backdrop managements are likely to be cautiously optimistic and conservative in their commentary about the future. As a result the bottom-up earnings forecasts for many companies, which have been declining rapidly, could be reduced further, and our current base case assumption may have to be trimmed.
We have specific expectations for each of our holdings as it relates to revenues, earnings, and guidance. Should there be meaningful changes to our assumptions or our investment thesis, we will take appropriate action and maintain a solid pipeline of investment ideas. We believe our focus on high-quality companies with solid earnings visibility will serve us well as the Battle Royale continues.
