To an extent, the volatility seen at the end of 2018 was driven by concerns around the potential for an earnings recession in 2019. Investors worried that softer global growth, coupled with uncertainty around both trade and monetary policy, would lead profit growth to stall in this year. The recent deterioration in earnings guidance has only added to this dynamic.
Although the risks to 2019 profit estimates appear skewed to the downside, we believe the 4Q18 earnings season will show that the robust earnings growth seen over the course of last year continued into year-end. The cyclical sectors - particularly energy, financials, and materials - likely saw solid earnings growth in 4Q18, but there are some risks that current forecasts are a bit too high. Energy prices declined notably in 4Q, with WTI oil prices falling by over 45%, which has the potential to weigh on the profitability of some companies in the sector. Furthermore, it is unclear whether the uptick in equity and bond market volatility at the end of 2018 translated into stronger trading revenues for financial firms, and technology companies may struggle from a growth standpoint due to the very good earnings seen at the end of 2017. That said, we still expect double-digit earnings growth from a year prior, which will hopefully allay some fears that a more significant deterioration in earning is lurking around the corner.
Looking forward however, more significant risks are beginning to build. The combination of lower energy prices and a stronger dollar will likely weigh on the more globally-exposed sectors at the start of 2019. More broadly, continued tightening in the labor market should lead wage growth higher, putting downward pressure on corporate profit margins. We believe profit margins peaked in 3Q18; although we believe that margins revert to the trend, rather than the mean, this key driver of earnings growth looks set to shift from tailwind to headwind. Furthermore, globalization and the ability for firms to leverage low-cost manufacturers has been a significant driver of margin expansion over the past 30 years, but any further escalation in trade tensions could put this dynamic at risk.
Calendar year consensus EPS estimates
Indexed to 100 on 9/30 of the prior year
Source: Standard & Poor's, FactSet, J.P. Morgan Asset Management.