For the markets, it’s all downhill from here

Inflection point.
Inflection point.
Image: REUTERS/Brendan McDermid
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It’s all downhill from here.

That’s the theme of earnings season thus far, with a majority of companies beating expectations for sales, profits, and much else besides. Some 70% of S&P 500 companies that have reported fourth-quarter financial results in recent weeks surpassed earnings expectations, according to FactSet.

Yet here’s the thing: At the same time, guidance for profits this year has been pretty grim. Three times as many firms have told the markets that first-quarter earnings will come in below expectations than above them. Netflix is a good example of the trend.

For the first time in years, analysts think that corporate earnings growth, in the aggregate, will shrink instead of grow. In part, this is because things have been so good in previous quarters, propelled by strong economic growth, tax cuts (hello, buybacks), and other “constructive” factors, as a sell-side analyst would say.

This time last year, stock pickers figured that the first quarter would continue the streak of double-digit percentage earnings growth recorded over the previous two years. As time went on, doubts crept in. Forecasts were cut and then turned negative around the turn of the year, when Apple dropped a profit warning on unsuspecting markets with a thud.

Since then, instead of the steady growth of previous quarters, the moves have been messy and idiosyncratic. Goldman Sachs is minting it, but Morgan Stanley missed badly (paywall). Facebook had a blockbuster quarter, but investors fretted about Alphabet’s shrinking margins. Similar patchiness can be seen in just about every sector you choose.

It feels like an inflection point has been reached. We are past the peak, so the question now is whether we will see a gradual deceleration or a sudden drop. The long stretch of economic expansion and aging bull market are at risk from trade tensions between the US and China, Brexit, rising interest rates, and other “headwinds” (another popular turn of phrase among analysts).

Investors have reacted with relief as the latest batch of earnings have mostly been better than expected. As the cycle turns, what happens if the next group of reports are even worse than feared?