Q4 Earnings Estimates Fall Sharply

Consumer Credit Falls

In August, the increase in consumer credit outstanding fell from $23 billion to $17.9 billion which beat estimates for $17 billion. Decline in credit growth was caused by revolving credit which was up $9.4 billion in July and down $2 billion in August. A slight decline in revolving credit card debt makes sense because income growth was higher than spending growth. 

Interest rates on car loans and credit card loans fell from Q2. In August, 48 month and 60 month loans had a rate of 5.27% which was down from 5.35% and 5.36%. Credit card rates fell 3 basis points to 15.1%.

It’s not a surprise consumer credit growth fell in August because the savings rate increased. While it’s fair to say the savings rate rose and revolving consumer credit fell because of worries about the trade war, let’s not pretend these were big moves. The savings rate is 8.1%; it peaked at 8.8% in February. 

Worries about the trade war aren’t as significant as the worries about the government shutdown. Investor worries about consumer spending are more significant now because the economy is cyclically weaker and because the trade war can drag on much longer than government shutdowns. Government shutdowns are much easier to resolve.

The trade war is attempting to resolve Chinese intellectual property theft which has been going on for years. Anyone complaining about how long it has taken to make a deal or surprised it has taken so long needs to realize how tough these issues are to solve. 

That being said, a lot of the complaints center around the fact that the White House has claimed a deal has been close for months. Promises about a trade deal coming soon still seem to boost stocks probably because of algos. Algos determine how markets react to news immediately after it comes out. Unless you have a time horizon of less than 1 day, you shouldn’t react to news on trade unless the reports show good reason to suggest a deal is close.

Q3 Earnings Season Scorecard

Q3 earnings season is just beginning. Earnings season will ramp up next week with the major banks reporting results. Citigroup, Wells Fargo, Goldman Sachs, and JP Morgan will report next Tuesday October 15th. Bank of America goes on October 16th and Morgan Stanley goes on the 17th. First of the FAAMNG names, Netflix, reports on the 16th.

As the table below shows, 21 firms have reported earnings. 86% of them have beaten EPS estimates on 2.9% growth and 57% have beaten sales estimates on 3.12% growth. 76% of firms have reported positive EPS growth. It’s likely Q3 EPS growth will be positive. Estimates are usually beaten and expectations heading into the quarter were slightly worse than -1%. Key is how Q3 earnings impact Q4 estimates. Q4 estimates show the quarter will have the highest growth of 2019. It’s the first quarter in 2019 without extremely tough comps.

The chart shows the average decline in Q4 estimates from the first 21 firms to report has been 3.76%. That’s much worse than the 1.77% decline last quarter. Last quarter was in line with the 3 year average, while this quarter is much worse than average. That could be signaling a new downtrend. Q4 estimates were clearly too high. On the one hand, they have started out higher than recent quarters. On the other hand, Q4 faces easier comps.

We can blame the weakening cyclical economy for the estimate declines. If this trend continues, stocks will fall unless there’s a trade deal. In theory, if the more moderate Joe Biden does well in the October 15th Democratic debate, it could help stocks. It should at least help the financials and healthcare. Problem is after every debate his polls have fallen, so I wouldn’t bet on that occurring.

As per usual, you can’t make too many assertions based on just 21 firms’ results. Only firms in 4 sectors have reported. Let’s wait until the end of next week to make bigger assessments. Overall, I wouldn’t be surprised if Q3 isn’t great for Q4 estimates because of the cyclical slowdown. 

Hard data is better than soft data, but it’s not exactly great. Goldman Sachs’ business activity indicator has 0.4% growth in soft data and 2.5% growth in hard data. I think that gap is being caused by the trade war, meaning I don’t see hard data cratering. Just because I don’t see a recession, doesn’t mean 2H 2019 will have a strong economy.

Potential Drag From Tariffs

The trade war is a factor for economic growth even though the results don’t fully show it yet. I’d say most of the reason economic growth has been weakening is because of the cyclical slowdown, but some of it is because of the trade war. The impact of the trade war will increase if the planned tariffs are implemented. It remains to be seen how impactful the cyclical weakness will be in 2020 because it could shift to strength.

The chart below shows the China tariffs’ potential impact on real GDP growth in 2020 based on the sensitivity of private sector confidence and volatility. If the economy is severely sensitive to tariffs, GDP growth could be impacted by 1.2% and if it has low sensitivity the impact could be 0.4%. I like this analysis because we don’t know for sure how the tariffs will impact confidence. Based on the survey data, I lean towards expecting there to be a big hit to confidence. However, I see a trade deal or halt to the tariffs coming, so I’m not bearish.  

Conclusion

Cyclical weakness is driving declines in earnings estimates and weakness in hard data. Soft data is worse than hard data because of the trade war. It should have a big impact on 2020 growth if the situation isn’t resolved and the planned tariffs go into effect this year. 

To be clear, the chart above shows the next tariffs going into effect on October 1st, but the date was delayed until the 15th. Besides hurting soft data, it appears the trade war is causing consumers to spend less, save more, and take out less credit card debt. Revolving credit card debt fell the most since this March. 

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