Stocks are set to close higher for the week as we wrap up what has been a disappointing month and year. The S&P 500 is down 10% in December and 7% in 2018 after peaking with a 10% year-to-date gain in late September.
Federal Reserve tightening and heightened uncertainty heading into 2019 have brought valuations on the S&P 500 to multi-year lows as investors anticipate slowing growth next year. Recent volatility has increased expectations for a potential recession on the horizon as the current cycle enters its tenth year. Increased political instability and a lack of liquidity during holiday trade have exacerbated recent swings while there was little in the way of corporate developments.
That will change in January when we will start to see a myriad of preannouncements for the fourth quarter and even some preliminary outlooks for 2019.
According to FactSet, S&P 500 earnings per share are expected to grow 20.6% this year. While tax cuts have provided a notable tailwind, earnings before interest expense and tax (EBIT, or operating profits) are still expected to grow an impressive 11.6%. Earnings for the fourth quarter are currently expected to grow 12.5%.
However, focus turned to 2019 months ago, and concerns over slowing growth have weighed on the market. Earnings are expected to grow a still healthy 7.7% next year, but that is down from 9% in early November as third quarter earnings season wound down. Estimates for double-digit earnings growth have often proven optimistic during this economic cycle. The last two years were the exception under the business-friendly Trump Administration, but elevated uncertainty appears to provide extra risk to forecasts for next year.
The rubber will meet the road in the coming weeks when companies unveil their forecasts for next year.
Select retailers will provide an update on how the all-important holiday season went starting on Thursday, January 3 and thereafter. Holiday sales were robust as the U.S. consumer has remained strong. MasterCard Spending Pulse reported holiday sales up 4.9% earlier this week, with online sales up 18%. For retailers, focus will be on earnings as investors want to see companies profit from the favorable environment as the shift to eCommerce continues to weigh on margins.
Corporate guidance will really pick up starting in the second week of January when the extended holiday period truly comes to an end. After a heavy preannouncement season, fourth quarter earnings season will kick off during the third week of January.
The U.S. Securities and Exchange Commission allows companies a larger window to file their annual reports relative to quarterly updates. As a result, we will see preannouncements throughout January and fourth quarter earnings season will drag on into March. Companies want to keep investors abreast on how 2018 wrapped up, and that buys management time to report their official numbers for the year while gaining additional clarity on 2019.
Coming back to a big picture view, slowing growth overseas and here in the US, tighter monetary policy from the Federal Reserve, political instability and trade uncertainty have all weighed on equities in recent months.
According to Capital IQ, the S&P 500 trades at 15.8x 2018 earnings estimates, 14.8x earnings estimates for the next twelve months and 14.4x 2019 earnings estimates. That represents a near five-year low and a notable discount to the thirty-year average of just under 17x. Excluding the real estate sector (where earnings aren't necessarily the most relevant valuation metric), the consumer discretionary sector is the most expensive sector at 18.5x next twelve-month earnings estimates, followed by consumer staples at 16.9x and utilities at 16.6x. The financial sector is by far the cheapest relative to earnings at 10.5x, followed by energy at 13.6x and industrials at 13.7x.
While trade, economic data and the Fed's reaction to those developments remain key wildcards in the outlook for 2019, investors will welcome clarity in the form of some bottoms up perspective from Corporate America in the coming weeks and months.