Falling Third Quarter Profits Could Trigger Overdue Stock Market Crash

Stock prices follow earnings growth. The stock market reflects earnings expectations.

That’s why analysts are concerned that the Q3 earnings forecast for the S&P 500 is for a decline of 0.3 percent, according to Factset data cited in CNBC. Declining earnings imply declining stock prices.

Earnings Growth Going the Wrong Way

Because Q2 earnings for the stock market are coming in negative – and Q1 did also at -2.3 percent – there is growing concern about the stock market’s valuation.

That’s with good reason. The stock market is presently the second most expensive in history and overdue for a big crash.

That kind of valuation requires year-over-year earnings growth that is spectacular, not declines.

This data cannot be viewed in a vacuum.

Trade War Takes Its Pound of Flesh

Much of the decline is linked to the U.S.-China trade war. That battle has had a significant impact on companies that do more than 50 percent of their business overseas.

FactSet reports that those stock market companies will likely see an earnings decline of 9.3 percent in the quarter. Domestic-heavy companies will likely see an earnings increase of 1.4 percent.

John Lynch, chief investment strategist at LPL Financial, reportedly says:

“Policy uncertainty is high, especially on trade. We have reduced earnings estimates to acknowledge the increased risk of a prolonged trade conflict. We remain optimistic that these trade disputes can be resolved this summer, though probably not until more economic pain is inflicted on the U.S. and China economies.”

The trade war is a temporary factor. It will resolve at some point. Therefore, investors should be cautious about reading too much into the overall earnings decline with respect to the stock market.

Other Factors Remain

There are also other factors buffeting the earnings situation. David Lefkowitz, the senior equity strategist for the Americas at UBS Global Wealth Management, tells CNBC:

“Tariffs are part of the story. But I also think there are a number of other factors that are driving some pockets of weakness in the global economy and the earnings picture for the U.S. economy.”

Bargains Can Be Found

While the overall stock market is overvalued, that also does not mean that individual companies are all overvalued. Many undervalued companies are in the market, including undiscovered small-cap stocks with substantial upside.

It is the large-cap growth names that investors love, like Apple, Intel, Google, Boeing, and others, that will continue to be hit by the trade war. The play with these is to wait it out and pick up bargains as they occur.