Heading into second-quarter earnings season, investors are looking for a continuation of strong U.S. company results to justify high stock valuations, now trading near their loftiest levels since 2004.
However, drilling a hole into that hopeful scenario is the current bear market in oil prices and an economy showing signs of growth below the pace expected earlier in the year.
‘Not trivial’
“A lot of the expectation for a recovery in earnings is predicated on oil prices being around $47-$50 a barrel,” said Hugh Johnson, chief investment officer of Hugh Johnson Advisors LLC. “So if you don’t get those numbers, you don’t get the strong earnings the stock market needs. This is not trivial stuff. It creates a lot of uncertainty and volatility in forecasts.”
U.S. crude futures have been pressured lower by a supply glut. They’ve averaged over $48 per barrel so far this quarter, but traded around $43 on Friday and are down more than 20% from February, when they hit an 18-month high.
U.S. stocks are in the ninth year of a bull run which has been fuelled of late by bets on pro-growth policies from U.S. President Donald Trump. However, with the timetable for reforms stretching further into the future, earnings are seen as a critical support for stock prices.
Earnings expectations have dropped for 10 of 11 industry groups since early April, with only industrials looking better than they did then. The S&P 500 stock index as a whole is expected to deliver 7.9% profit growth, down from 15.3% in the first quarter, and below the 10.2% forecast in April, Thomson Reuters data shows.
On Thursday, Nike will be the first Dow component to report earnings for the most recent quarter.
While lower energy prices can help some sectors such as industrials and transports, as well as boosting consumer sentiment, high expectations for energy earnings growth mean any stumble will be felt broadly. Energy sector profits are seen up a whopping 683% from a year ago, when many companies posted losses.Without energy, profit growth estimates drop to 4.8% for the quarter.
Expectations for the sector will probably have to come down for the second half of the year if low oil prices persist, said David Joy, chief market strategist at Ameriprise Financial in Boston. “The one wild card right now is the price of oil,” he said.
