World Economy

Slumping Profits May Cause S&P to Swoon Soon

Slumping Profits May Cause  S&P to Swoon Soon
Slumping Profits May Cause  S&P to Swoon Soon

The two-quarter retreat in Standard & Poor’s 500 Index earnings is about to become a three-quarter swoon, and this time it isn’t just because of plunging energy prices.

Bank profit estimates are falling at the fastest pace in four years, bringing the overall forecast for S&P 500 earnings in the fourth quarter to a decline of 5.6%, compared with a gain of 1.4% as recently as August. Financial institutions are exerting an ever-increasing drag on analyst projections: what had been expected to be a 16% surge in their October-to-December income has narrowed to less than 1%, Bloomberg reported.

While the deterioration reflects subdued trading forecasts for some of the country’s biggest lenders, it illustrates a broader truth: that once profits start to decline in one area of the economy, it’s hard to keep weakness from spreading. Now it’s happening to the S&P 500’s biggest earnings contributor at a time when weakening income represents a growing risk to the 6 1/2-year old bull market.

“It’s another sector that is essentially faltering in the face of the economy, which is giving every indication of a further slowdown if not outright recession,” said James Abate, who helps oversee $1 billion as chief investment officer at Center Funds in New York. “You’re seeing sector by sector starting to basically wither. If you get an environment where earnings continue to drop in a very high-expectation world, that’s a recipe for a difficult, if not a corrective, market.”

 Embedded Valuation

Those expectations are embedded in valuations, with the S&P 500 trading at a price-earnings ratio of 18.7, compared with the 10-year average of 16.6. As a precaution against equity losses, Abate’s firm owns options that appreciate should the broader market decline and favors companies whose earnings have shown resilience, such as Inc. and Alphabet Inc., Google’s parent. S&P 500 futures rose less than 0.1% in London.

Earnings in the S&P 500 posted their worst slump since the financial crisis in the quarter that ended Sept. 30, falling 3.3% during a stretch that saw stocks suffer their first correction in four years. Banks and brokerages, whose 21% share of the index’s profit so far this year tops any other industry, experienced a 6.5% income drop.

Financial earnings growth is seizing up after holding firm in the face of oil’s collapse and a strengthening dollar, which pummeled commodity and industrial sales. From Goldman Sachs Group Inc. to Morgan Stanley, estimate cuts are piling up after the Federal Reserve delayed its first interest rate increase in almost a decade and JPMorgan Chase & Co. said in October that analysts’ expectations were too high for the rest of the year.