Following a surge in corporate earnings following US president Donald Trump’s ‘sugar rush’ tax overhaul in 2018, growth forecasts have fallen back.
Yet, with companies’ earnings having surpassed estimates in the past some analysts are allowing themselves to become a bit more optimistic.
But this may be misplaced, according to the Unigestion cross-asset solutions team.
The Swiss asset manager believes that payouts by S&P 500 companies have revealed a different picture of “anaemic earnings growth for the coming years”.
“Since Donald Trump took office, annual S&P 500 profits have grown at twice their historical rate,” said the team. “Obviously any discussion of the president’s impact on profits begins with the corporate tax overhaul.
“However, upside surprises of this magnitude are rare and tough to repeat, and earnings growth forecasts are back to the usual pattern – deteriorating over time.”
The cross asset solutions team added: “Given the historic trend that many companies’ earnings surpass estimates, we believe that we could end the quarter in slightly positive territory.
“But even if we get marginally positive earnings this quarter, the trend has clearly changed since the tax overhaul. With earnings-per-share growth stalling, market performance depends on low rates more than ever.”
Indeed, the latest Bank of America Merrill Lynch Global Fund Manager Survey revealed that asset allocators remain bearish about the outlook for corporate earnings, with 35 per cent of respondents expecting growth to deteriorate over the next 12 months.
Net per cent say global profits will improve
Source: Bank of America Merrill Lynch Global Fund Manager Survey
During the second quarter of the year, year-on-year earnings growth was the weakest since the 2015-2016 earnings recession, according to Unigestion.
And when excluding buybacks, the S&P 500 posted the first quarterly year-on-year decline in three years during Q2.
“The tone during the earnings calls was very cautious, suggesting very low levels of optimism, the lowest since Q2 2003,” said the team. “One in five companies in the S&P 500 mentioned negative impacts from the tariffs and trade dispute.
“Uncertainty about the economy and the trade situation has led to postponement in big investments in buildings and equipment.”
While Q3 earnings have beaten estimates by around 3.7 per cent on average in the first few days of the reporting season, the dividend market could be telling a different story.
“Dividends tend to be far less volatile year-on-year than respective share prices, although both are influenced by the capacity of a firm to generate earnings,” they noted.
“Companies normally manage shareholder expectations using long-term dividend payout targets, but they can also try to maximise shareholder satisfaction by deciding to temporarily deviate from its policy.
“Shareholders often use dividend payments as the main indicator of a company’s health and of management’s performance.”
As such, companies are more likely to increase payouts when earnings fall than they are to decrease payouts when earnings rebound.
“In 2018, the payout ratio equalled 88 per cent of earnings with about two thirds coming from buybacks and one-third from dividends,” the firm noted. “A 50 per cent share repurchase increase to an all-time high of over $800bn in the same year triggered a big public debate about the use of corporate cash in Washington and beyond.
“In contrast, dividends no longer seem to attract attention despite a steady average annual rise of 7 per cent over the past decade.
Despite more upbeat earnings expectations, however, the dividend market is pricing in an “anaemic” 0.7 per cent annual growth over the next decade, according to Unigestion.
“To put that number into perspective, the S&P 500 dividend-per-share growth has never averaged below 2.2 per cent in any 10-year period since 1950,” they added.
“Moreover, dividend markets have been much more resilient during recessions.”
With the asset manager’s indicators showing a low risk of recession and low risk of inflation surprise, dividend-paying stocks should offer “a very compelling risk-reward”.