Revenue growth among S&P 500 Index (SPX) companies is experiencing a
marked slowdown, and this has negative implications for the future trend of
profits and stock prices, given that these companies also are under increasing
pressure from rising costs. With 75% of the S&P 500 companies having
reported 3Q 2018 earnings thus far, the latest U.S. Weekly
Kickstart report from Goldman Sachs observes: "sales results have
been disappointing, as only 29% of firms beat expectations, below the long-term
average of 35%. The scarcity of sales beats has been reflected in stock
returns." Given that U.S. GDP grew at a still-brisk annualized rate of 3.5% in 3Q
2018, the reduction in positive surprises, as detailed in the table
below, is especially worrisome.
Companies reporting 3Q results so
far have delivered, on average, a positive revenue surprise of 1%, equal
to the figure for 2Q 2018, but half the 2% average surprise in 1Q 2018 and 4Q
2017, per Goldman. As the table below illustrates, year-over-year
(YOY) sales growth for the S&P 500 as a whole is projected
to decline by 40% from 2018 to 2019, with 5 industry sectors expected
to endure even more dramatic decreases in their own sales growth rates
that range from 50% to 100%.
"Tariffs, wage inflation, and
rising interest rates pose three key risks to all-time high S&P 500 profit
margins," the report leads off. On tariffs, Goldman says:
"the actual impact of tariffs on 3Q results was minimal because
implementation of the 10% levy on $200 billion of imports from China only
started on Sept. 24. However, the tariff rate is slated to jump to 25%
starting in January 2019 and an additional $267 billion of imports may be
subjected to a 25% tariff."
Many businesses indicate that
they are maintaining profit margins by passing along the cost of tariffs
through price increases, Goldman says. Others are
adjusting their supply chains, moving production away from China or
switching to vendors in other countries. However, price increases inevitably
will reduce demand, limiting the prospects for future sales growth.
Rising interest rates not only are
adding to the funding costs of non-financial businesses, but also are dampening
demand in key sectors, such as housing. As detailed in another
Investopedia article, rising rates are dampening housing
starts and new home sales, causing homebuilding and related
stocks to plunge. The projected stalling of sales growth in the materials
sector, as indicated in the table above, is partly the result of these negative
developments in the housing market.
Rising wages represent a
double-edged sword for business: they put pressure on profit margins, but they
also raise demand, as long as wages are rising at a faster pace than consumer
prices. However, as Goldman notes, an inevitable result of a tight labor market
and rapidly rising wages is that companies are looking to boost productivity and
possibly reduce headcount through measures such as increased automation.
Given that sales revenues are a prime
mover of profits and stock prices, the deceleration in sales growth has large
negative implications. In this environment, generating earnings growth will
depend increasingly on cost control, if not outright cost reduction, a
considerably more difficult task for many businesses.