Markets have been on a rollercoaster, as expectations for slower economic and profit growth have begun to crystallize and concerns about a more hawkish Fed have taken hold. As we have said for a while, economic growth through the middle of next year should average 3%, but will then decelerate towards 2% barring no additional stimulus. At the same time, the robust pace of profit growth seen this year will not be maintained in 2019. The market is finally beginning to internalize that.

However, the third quarter earnings season is underway, and our expectation is that another solid series of reports may help temporarily alleviate some of these concerns. Companies continue to benefit from tax reform, above-trend economic growth, a moderate rise in wages and manageable interest rates, with results from energy, health care, and technology companies expected to be particularly good. Furthermore, while financial companies in aggregate should benefit from easy year-over-year comparisons due to the negative impact of the 2017 hurricanes on insurance company bottom lines, initial reports suggest capital market activity was a bit soft in 3Q. On the other hand, profits in the consumer staples sector appear to have contracted due to higher commodity prices and rising input costs.

That said, broader risks to the earnings outlook are beginning to materialize, as rates and wages are both rising, suggesting margins should start coming under pressure. Furthermore, bond yields are beginning to look more attractive, suggesting that profits, rather than multiples, will be responsible for the majority of equity returns going forward. We maintain the view that earnings growth will slow, but not stop, in 2019; however, tariffs remain a wild card, and if they are applied to all Chinese imports, it could leave a significant dent in 2019 profits.

Our more tepid outlook for earnings next year does not mean it is time to get out of stocks, but rather to focus more on income and make sure portfolios are balanced. The sun is still shining on equity markets, but it would be prudent to fix the roof before the rain begins.

The risk to profits in 2019 is that margins begin to come under pressure

Quarterly operating earnings per share/sales per share

Source: Standard & Poor's Compustat, FactSet, J.P. Morgan Asset Management.
3Q18 earnings are calculated using actual earnings for 8.5% of S&P 500 market cap and earnings estimates for the remaining. Data are as of October 18, 2018.