Earnings Trouble Around The Corner

Written by Dennis Slothower
Posted June 22, 2018 at 8:00PM

As we come into the end of the quarter, institutions are sizing up what’s on the horizon. Stocks on Thursday fell sharply, especially the energy stocks, going into Friday’s OPEC announcement.

This sent the energy sector into a tailspin on Thursday ahead of the announcement and, in turn, caused the Dow 30 to break its minor support at the 50-day moving averages — now falling to test its 200-day moving average (primary support) at 24,253.

The OPEC announcement was seen as modest, leading to a sector recovery, but Friday's trading left the Dow 30 at the 50-day MA and easily within range of the 200-day MA.

What is especially worrisome is the entire commodity complex is breaking down. Oil, precious metals, and grains are selling off relative to a global economic slowdown occurring with Europe, China (Shanghai Composite down 19%), and emerging markets. All of the commodity segments are feeling the hit.

If the economy was improving and healthy, commodity prices would be appreciating. They seem to be anticipating a deflationary slowdown, though. Clearly, the data isn't enough to overcome worries about climbing interest rates in this sector.

Remember what we discussed before. After the 4th of July, seasonal weather begins to cool going into the fall months. Yet we now have OPEC poised to increase its oil production, meaning demand for oil should start to turn down with oil production increasing to make up for Iran’s loss of oil production. This is pressuring the energy sector.

Earnings Trouble in Second Half of Year

When the oil market “peaks” and rolls over — being the best performing sector within the S&P 500 — corporate earnings will become vulnerable in the second half of the year.

Due to the tax cuts and the adjustments on the accounting books for many corporations, the first quarter of this year also saw a whopping 21.7% growth rate.

Massive share buybacks created a sharp rise in profits, and the new tax law gave companies certain write-offs that also boosted earnings in the first quarter.

Notice how outstanding shares have been declining steadily. This is because major corporations have been borrowing capital and issuing junk bonds to buy back shares and to pay out dividends. This is financial engineering, and most people haven’t a clue companies are doing this to boost their earnings.

However, as interest rates climb, this becomes more costly for companies. Most stocks “peaked” at the end of January, having already factored in their best earnings. But now, at the end of the second quarter, the S&P 500 companies are going to have a hard time repeating the first quarter’s performance. The short-term boost becomes a longer-term liability.

In the second quarter we have seen a rising dollar, higher gasoline prices cutting into corporate profits to transport their goods, rising wages pressuring profits, and a global economic slowdown compounded by higher interest rates. All evidence suggests that earnings are going to disappoint by failing to beat the first quarter’s growth.

With the onset of a likely trade war, it could reduce earnings growth by 11%! China announced on Wednesday, in retaliation to President Trump’s $200 billion tariff on China’s goods, that it will reduce U.S. oil imports after September. It is also considering a 25% tariff on U.S. imported oil.

The ultimate aim of the U.S. is to get all nations currently imposing tariffs on U.S. goods to drop their tariffs altogether, but these new tariffs are unlikely to succeed unless it’s painful for other countries. The President is playing hardball — and he needs to — but in the meantime, tariffs will take a toll on corporate earnings in the second half of 2018.

This is why we are seeing the broad market indexes and the industrials struggling to get back to their January highs. Earnings are vulnerable going forward.

The Dow 30 is now closing in on another retest of its 200-day moving average, having already tested primary support four times. This is the fifth test.

To your wealth,

Dennis Slothower Signature

Dennis Slothower
Editor, Stealth Stocks Daily Alert and Wall Street's Underground Profits

Dennis Slothower has been leading a small but profitable group of investors to some extraordinary profits in both good markets and bad over the course of a 38+ year investment career, starting as a stock broker in 1979. In 2011 Dennis was named the top performer by Hulbert Financial Digest for avoiding the Crash of 2008. Now, he is bringing his extensive experience to the public through Outsider Club, Stealth Stocks Daily Alert, and Wall Street's Underground Profits. For more about Dennis, check out his editor page.

*Follow Outsider Club on Facebook and Twitter.


Investing in Marijuana Without Getting Burned