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Q3 Earnings: Will Growth Lift Stocks from Murky Trade War Waters?

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Last week, the Dow touched its first intraday all-time high since January, joining both the S&P 500 and Nasdaq Composite indexes in a return to peak form after stretches of inflation concerns and rate woes battered stocks in early 2018.

Adding to these headwinds over the late spring and summer months were a variety of trade-related headaches caused by escalating tensions between the U.S. and several key economic partners. Notably, President Donald Trump has clashed with China, Canada, Mexico, and the European Union as he seeks to renegotiate global trade agreements and rethink American supply chains.

An “America First” platform helped President Trump win his place in the White House, but few seemed prepared for the extent of the resulting tit-for-tat tariff battles and subsequent rise in input costs for U.S. companies.

This major uncertainty has limited gains in the stock market, which would likely be being blowing past previous watermarks as earnings and revenue growth, consumer confidence, and GDP expansion continue to paint a robust economic picture.

Now, with major indexes sitting cautiously near all-time highs and another earnings report season approaching quickly, Wall Street is faced with a major question: Will fresh results and updated guidance be strong enough to break stocks into new ranges?

Let’s take a closer look at the latest estimates and expert analysis to see if we can get a jump on Q3 earnings season before it really kicks off!

Recent Estimate Trends

Much has been said about the effects of recent tax cuts on our overall earnings outlook. There is no doubt that the reform package has buoyed bottom-line growth; however, it is worth noting that the earnings picture was pretty sound well before the new laws took effect.

Still, the changes did result in a positive earnings estimate trend for preceding periods. Estimates were already strong, but positive revisions poured in as analysts factored in updated effective tax rates. This has, of course, started to wear off, and now were are seeing a downward trend in estimates:

Estimates have come down since the fiscal third quarter began, but we are still expecting to see average earnings growth of 17.6%. We should also remember that a slight downtrend in estimates over the duration of the quarter was a normal occurrence prior to the tax cuts.

One bullish sign is that estimates in the Technology sector, one of the largest sectors in terms of its contribution to overall earnings, have ticked slightly higher. Investors should acknowledge that positive revisions from behemoths such as Apple (AAPL - Free Report) and Alphabet (GOOGL - Free Report) have helped the broader outlook in the Technology sector.

Earnings growth is expected to be in double-digit percentages for 10 out of the 16 sectors defined by Zacks for the Q3 period. Energy, Finance, Construction, Basic Materials, and Technology are expected to see the strongest growth, while Conglomerates and Autos are projected to see modest declines.

Expert Expectations

Another way to prepare for the upcoming earnings season is to follow the sentiment emerging from Wall Street’s top voices ahead of the busy period.

In a recent earnings trends report, Zacks’ own earnings guru, Sheraz Mian, described the earnings growth picture as “very strong”—even in the face of decelerating growth expectations in the current and upcoming quarters.

“But more important than the growth rate is the revisions trend, which reversed course after staying broadly positive over the last three quarters,” Mian wrote. “Given the ongoing strength in the U.S. dollar, questions about the global economy and all-around trade uncertainty, it is possible that estimates for Q3 and beyond continue coming down in the coming days.”

Mian’s comments touch on the power of both expectations and uncertainty. Wall Street has grown accustom to nearly 20% earnings growth in recent quarters, so anything less than that is unlikely to impress investors. Moreover, the lingering uncertainty of trade wars could kill earnings optimism and result in further downtrends in estimates.

But the question we posed earlier—whether Q3 earnings season will inspire more gains—could be extended to an even broader perspective, as a stock market that is unwilling to push higher might be one that attracts alternative investing strategies.

However, some on Wall Street are not willing to say that stocks are unattractive just yet. David Lafferty, a senior VP at Natixis Global Asset Management, for example, thinks forward earnings growth is still impressive enough to make stocks more appealing than bonds.

“I think the euphoria around the economy and forward earnings growth is swamping this yield comparison idea that bonds are starting to look more attractive than stocks,” Lafferty said.

Bottom Line

Lafferty’s thesis is important because it reminds us that our bull market might only face longevity problems once other strategies look like better deals than stocks. Cash and fixed income plays might be getting more appealing in the face of trade wars and rising interest rates, but there are still reasons to be bullish on stocks right now.

What’s more, if trade negotiations eventually do pan out, another strong earnings season is going to look even stronger after the removal of the market’s biggest headwind. This could set investors up for a great finish to the year.

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