Profits continue 3rd quarter slide but recession fears subside

NEW YORK — Corporate profits continued their yearlong slide during the third quarter and analysts expect another decline this quarter before the numbers start improving.

Companies have been hindered by slower global economic growth, worsened by the U.S.-China trade war, in their efforts to increase profits from a year ago. Many with international supply chains have faced higher costs, and several sectors have seen declining global revenue.

U.S. companies are also having a tougher year by comparison to 2018, when sharply lower corporate tax rates helped goose profits.

Analysts expect profits to resume growing in the new year, starting slowly in the first quarter and accelerating after that. Much of the optimism centers around hopes for a resolution to the trade war and companies getting a clearer picture of where the global economy is headed.

Drops taken in stride

Wall Street has taken this year’s quarterly profit contractions in stride, largely because companies, for the most part, have managed to beat already low forecasts. Analysts came into the third quarter expecting profits for the S&P 500 to fall 4%. With 97% of companies in the index reporting, profits are expected to have declined by 2.3%, with three-quarters of the companies topping expectations.

Reassured by those results, investors have instead focused on the broader U.S. economy and the Federal Reserve’s moves to lower interest rates. Consumer spending remains strong, with unemployment close to a five-decade low. Inflation is also restrained. Those have contributed to steady, if not spectacular, economic growth around 2%.

Fears of a U.S. recession, tied largely to a drop in manufacturing activity, have recently subsided.

“There’s no question earnings are challenged,” said David Kelly, chief global strategist at JPMorgan Asset Management. “The market is to some extent coasting off good stable job performance.”

Buying mood continues

Investors have been in a buying mood all year. The S&P 500 is hovering around a 25% gain for the year, while the tech-heavy Nasdaq is on track for a 30% gain.

Companies that beat analysts’ forecasts in the third quarter saw an average price increase of 2.2% within the four-day period surrounding their report, according to John Butters, senior earnings analyst at FactSet. That is well above the five-year average price increase of 1% during that same window.

Investors have also been taking it relatively easy on companies that fell short of the mark, according to Butters. Companies that fell short of expectations saw an average price decline of 1.7% during that four-day window. That’s smaller than the five-year average price decrease of 2.6% during that same window for companies falling short of expectations.

Katie Nixon, chief investment officer at Northern Trust Wealth Management, said investors have been responding more to economic data and policy, along with trade developments.

“We are in jet propulsion mode right now as investors focus on the holy trinity of low, but positive growth, low inflation and accommodative central banks,” she said.