A Stock Market Correction? What About Corporate Earnings?

The big question now is whether the stock market will correct in January -- and, if so, to what extent.  Those looking for a correction see anywhere between a 3-10% decline in the S&P 500.  All, however, view a pullback as a buying opportunity -- which argues for only a modest decline if this is generally believed.  While corporate earnings expectations do not appear particularly troubling, a high Price/Earnings (P/E) Ratio is a concern.  Stocks may have outrun fundamentals.  A trigger for a correction could be soft key macro-economic data in early January.  At this point, evidence points to a sub-50 December Mfg ISM and a smaller increase in December Payrolls than November's +266k.

Corporate Earnings
The Q419 earnings season, which will begin in a few weeks, should not precipitate a correction.  The consensus estimate has moved up.  Although it is still negative, it is less so than the y/y decline seen in Q319.  Macro evidence supports expectations of an improvement in earnings from Q319.  Further ahead, expectations are for strong earnings growth in 2020. 

According to Insight, consensus expectations for Q419 Corporate Earnings are now -1.4% (y/y), better than the -2.3% in Q319 and the Q419 consensus estimate of -2.5% made at the end of Q319.   FactSet says that while downward revisions for some companies have been relatively large, the percentage of companies making downward revisions was smaller than normal.  

The macro evidence supports expectations of better corporate earnings in Q419 than in Q319.  Real GDP Growth has sped up on a y/y basis, using the Atlanta Fed model's 2.3% estimate for Q419.  Oil prices have flattened out after sinking by double-digit rates in the prior 3 quarters.  Profit margins may have improved, as wage inflation slowed while price inflation was steady.  Oil profits should benefit from an easing in price deflation.  And, earnings from abroad should be better, as the slowdown in non-US economic growth stabilized as has dollar weakness. 

                                                                                                                                         Markit
                                                                                                                                          Eurozone              Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)
Q117            1.9                +65.3                  2.3                              2.7          2.2                55.6
Q217            2.1                +13.1                  3.1                              2.5          1.8                56.8
Q317            2.3                 +6.0                 -1.9                              2.5           1.7               57.4
Q417            2.5               +12.7                 -4.1                              2.5           1.7               59.7

Q118            2.6               +21.5                 -6.6                              2.7           1.9               59.1
Q218            2.9               +41.0                 -1.8                              2.7           2.2               55.9
Q318            3.0               +45.4                 +5.1                             2.8           2.2               54.3
Q418            3.0                 +6.7                 +6.5                             3.3           2.2               51.7

Q119            3.2                -12.8                 +7.9                             3.2           2.1               51.9 
Q219            2.7                -12.2                 +5.9                             3.1           2.1               47.8    
Q319            2.1                -19.2                 +3.6                             3.2           2.3               46.4
Q419            2.4                  -3.8                 +1.7                             3.1           2.3               46.2

FactSet says that consensus now looks for a 9.6% y/y increase in corporate earnings in 2020, which would be above the 9.1% 10-year average.  However, the Price/Earnings Ratio still would be high, with the S&P 500 expected to rise to 3430.  The forward 12-month P/E ratio would be 18.0, which exceeds the 5-year average of 16.6 and the 10-year average of 14.9.   A corrective decline in the S&P 500  to 3000 (-7.4% from Friday's 3240 level) would put this P/E ratio at 15.7.   This level would likely be viewed low enough to allow for a renewed rally.

P.S.    I just published a book that analyzes the theology of the Old Testament. The book's title is "Finding Judaism in the Torah" and is on amazon.com. While it does not involve economics or the markets that I write about on my blog, it uses the same objective analytical approach I apply to understanding the import of economic data.