Bull Market’s Latest Hurdle: Slowing Sales Growth (#GotBitcoin?)
Many S&P 500 companies point to cautious customers, rising costs and a stronger dollar as reasons for weaker quarterly performance. Bull Market’s Latest Hurdle: Slowing Sales Growth
Revenue growth at U.S. companies (including Amazon and Google) is slowing, stirring concern that a corporate-profit boom that has driven the Dow Jones Industrial Average and other major stock indexes to dozens of records in 2018 is in jeopardy.
Firms from asset manager BlackRock Inc. to computing giant International Business Machines Corp. this month have reported disappointing quarterly sales, citing such factors as cautious customers, rising costs and a stronger dollar. So far this quarter, 35% of the 85 reporting S&P 500 companies have missed Wall Street analysts’ sales forecasts, according to FactSet. If sustained, that quarterly sales-miss ratio would mark the highest this year.
The misses are contributing to the latest bout of stock-market volatility. The S&P 500 has shed 4.8% over the past month, driven by concerns about rising interest rates and trade disputes that pushed investors to dump technology stocks and shares of other fast-growing companies.
The fundamentals of the U.S. stock market remain mostly strong. Rising earnings, boosted by last year’s corporate tax cuts, have helped justify rich multiples and in some cases brought price-earnings ratios down. Sales growth remains solidly positive even if it is now falling back from the heady pace reached earlier this year.
Many analysts are now focusing on what the numbers might look like next year. If sales continue to slow in coming quarters, earnings growth will become more difficult to come by and a crucial pillar of support for markets will weaken, analysts said.
“We had a strong first half in the U.S. for growth and corporate earnings,” said Talley Leger, an equity strategist at OppenheimerFunds. “Right now, we’re staring at a softer second half heading into next year. That is the challenge for equity markets.”
S&P 500 companies are on pace to grow third-quarter sales by 7.3% from the same period a year earlier, according to FactSet. Though a far cry from the tepid, low-single-digit figures sometimes seen earlier in this cycle, it is the lowest growth rate for the broad index in four quarters.
While hardly anyone expects a recession soon, investors are worried about how the stock market will react to slowing profit growth. With the immediate boost from tax cuts in the past, profit growth among S&P 500 companies next year is expected to decline by half, while sales growth is projected to contract to 5.4% from 8.2%, according to FactSet.
For now, companies continue to benefit from the tax overhaul passed late last year, which has helped bolster a domestic economy already characterized by soaring consumer confidence and the lowest level of unemployment in nearly 50 years.
Those consumer benefits have filtered down to companies like Netflix, which said this past week that it added nearly 7 million new users in the third quarter and brought in $4 billion in sales, in line with analyst’ estimates. Shares initially rose, but investors’ waning optimism sapped Netflix of all of its gains for the week. Still, the stock remains up 73% for the year.
But the economy’s strength and the Federal Reserve’s interest-rate increases have helped drive up the value of the U.S. dollar, which tends to weigh on U.S. exports and the earnings of multinational companies by making goods produced here costlier overseas.
IBM, for instance, said this past week that its third-quarter revenue fell 2.1% from a year earlier to $18.8 billion, snapping the computing giant’s brief return to growth, even as profit topped expectations. James Kavanaugh, IBM’s chief financial officer, said the dollar’s rise dashed what would have been an otherwise flat sales quarter.
“The strengthening of the dollar is actually hurting our product-based businesses in hardware and software,” Mr. Kavanaugh told analysts on a conference call on Tuesday. Shares of IBM fell 8.3% this past week, extending its loss for the year to 16%.
There are signs that effect is washing through the system more broadly. U.S. manufacturing activity decelerated last month, as the Institute for Supply Management’s new orders gauge and its supplier delivery index both declined. In August, the Philadelphia Fed’s manufacturing survey hit its lowest reading in 21 months, while the Empire State manufacturing index fell in September.
While the S&P 500 remains up 3.5% this year, some money managers are urging investors to focus on more durable companies that have strong balance sheets, better pricing power and higher profit margins—businesses that are expected to better withstand an eventual economic slowdown.
Unilever PLC and Nestlé SA, for example, recently reported stronger sales after using the bump in inflation to raise prices. Shares of both companies rose more than 4% this past week, paring losses for the year.
But sentiment clearly is under pressure. The American Association of Individual Investors’ weekly survey indicated that the percentage of investors who expect stocks to fall over the next six months rose to its highest level in three months.
“Investors should be asking themselves at this stage how much better can things really get,” said OppenheimerFunds’ Mr. Leger. “Investors need to curb their enthusiasm.”
Google Parent Alphabet Delivers Surging Profit but Slowing Sales Growth
Alphabet reports overall revenue grew 21%, versus 24% in the same period a year ago.
Google’s parent reported surging profit on slightly slower growth in revenue, signaling uncertainty in its core business at a time when it is also dealing with a growing backlash from regulators and turmoil in its own corporate culture.
Alphabet Inc. on Thursday said net profit jumped nearly 37% to $9.19 billion in the three months through September, from $6.7 billion in the same period last year. That growth surpassed analysts’ estimates.
Overall revenue, however, grew 21% to $33.74 billion, versus 24% growth in the same period a year ago. Ad revenue, which accounts for the vast majority of sales, rose 20% to $28.95 billion.
The results come after a period in which Alphabet lost more than one-sixth of its market capitalization in the span of three months. The Google parent has been dragged down by an October stock-market retreat. Its shares on Wednesday reaching their lowest point in five months, before rebounding 4.4% on Thursday ahead of the quarterly report to close at $1,097.18. Shares slipped more than 3% after the close when results were issued.
Google has been fielding questions from lawmakers in Washington and Europe since The Wall Street Journal reported earlier this month the company never told users about a software bug that exposed the privacy data of hundreds of thousands of users. That incident led the company to shutter the consumer functionality of its Google+ social site.
Google has been racked by internal turmoil over the past year on issues ranging from its work with the U.S. military to its China plans to its handling of gender issues in its workforce.
In a memo to employees on Thursday, Google Chief Executive Sundar Pichai said the company has fired 48 staff members for sexual harassment over the past two years, according to a copy of the memo reviewed by The Wall Street Journal.
Alphabet had 80,110 full-time employees as of the end of last year.
Mr. Pichai’s memo came in response to a New York Times story saying that Google protected three senior executives over the past decade after they were accused of sexual misconduct, including one whom it gave a $90 million exit package when he left in 2014. Google declined to comment on details in the Times story.
Mr. Pichai said in the memo that none of those fired in the past two years received an exit package. Google is “dead serious about making sure we provide a safe and inclusive workplace,” he wrote.
Google said Thursday that its non-advertising businesses overall grew more quickly. Sales in its “other” revenue category, which includes cloud-computing services and hardware devices like its Pixel smartphones, rose 29% to $4.6 billion compared with $3.6 billion.
Growth in Google’s core advertising business remains rapid for such a huge company, but it faces several challenges.
Google is experiencing greater competition in its online ad business from Amazon.com Inc., which accounts for a growing number of product searches by U.S. users, said eMarketer Inc. analyst Andrew Lipsman. Google’s share of U.S. digital ad spending is expected to fall to 37% this year, down from 39% last year, according to eMarketer. Amazon’s share jumped to more than 4%, from 2% last year.
And Google has faced rising costs. Its payments to distribution partners accounted for 13.1% of revenue generated by the company’s website traffic, a higher amount than the company spent a year ago and in the second quarter of this year. That figure is closely watched by investors who are concerned Google is buying some of its growth through costly deals with Apple Inc. and others.
Revenue excluding payments to advertising partners was $27.1 billion, an increase of 22% from a year earlier but slightly lower than the $27.3 billion predicted by analysts.
The company’s capital expenditures grew 49% to $5.2 billion as it continues to spend heavily hiring employees and developing futuristic technologies.
“They are plowing all their cash into reinforcing their dominant position,” said Brian Wieser, senior research analyst at Pivotal Research Group. “The question is, are they going invest in products that sell more ads or build flying cars which may never take off?”
On a call with analysts, finance chief Ruth Porat said the bulk of capital expenditure increases were due to hiring technical talent, with the company’s cloud computing unit seeing the largest increase in staff.
Mr. Pichai fielded analyst questions about Google’s exploration of a China expansion, which has raised concerns the company would have to comply with the country’s strict internet censors. The CEO said Google is “constantly looking for ways by which we can better serve Chinese users” but declined to offer any specifics on the plan.
Amazon Reports Another Profit But Sales Underwhelm
Amazon.com extended its profitability streak to more than three years, but shares fell on slowing sales.
Amazon.com Inc. posted its second straight quarter of record profitability, but its recent string of blistering revenue growth is cooling. The company’s slower-growing Whole Foods Market business has weighed down gains, and its cloud-computing business faces stiffer competition.
The Seattle-based company on Thursday posted a profit of $2.88 billion—about 11 times last year’s figure—extending its profitability streak to more than three years. The company tamed some costs, including head count and shipping expenses, the latter of which rose only 22% compared with over 30% in recent quarters.
Revenue figures disappointed, however, and the company warned growth could slow in the latest holiday quarter.
Total sales in the third-quarter period increased 29% to $56.58 billion, Amazon’s slowest-growing quarter in more than a year and short of the average analyst estimate of $57.1 billion.
The results sent Amazon’s shares down 7.7% to $1644 in after-hours trading Thursday. The stock has rocketed this year, up roughly 50% and briefly pushing Amazon’s market value past $1 trillion in September, though it has fallen under $900 billion in recent weeks.
Amazon’s underwhelming sales growth shows that company, despite its surging revenue, isn’t immune to missing expectations as it stitches together a number of new businesses with its core online retail unit.
In particular, the roughly $13.7 billion purchase of Whole Foods in August 2017 is now starting to draw year-over-year comparisons, deflating the speed of Amazon’s apparent revenue growth. About one month of Whole Foods sales seeped into the year-ago quarter. Compared with the second quarter, sales of Amazon’s physical store segment—primarily Whole Foods—fell slightly to $4.25 billion from $4.31 billion three months earlier.
Even the company’s cash cow, Amazon Web Services, has showed some weakness relative to lofty expectations as rivals Microsoft Corp. and Alphabet Inc. chip away at market share. And Amazon’s international retail business also slowed down, largely because the company’s massive India business shifted some holiday sales to the fourth quarter.
For the current quarter, which includes the key holiday season, Amazon projected sales between $66.5 billion and $72.5 billion, below the estimate of $73.89 billion expected by analysts polled by Refinitiv.
While Chief Financial Officer Brian Olsavsky predicted a strong holiday season, the company left a wider error margin for its guidance for the fourth quarter because of a number of unknowns, he cautioned on an analyst call.
Much of Amazon’s revenue “comes in that very tight window between the middle of November and the end of the year,” Mr. Olsavsky said. “It’s always a very difficult period for us to estimate.”
Heading into the fourth quarter, a couple of factors are contributing to a wider range of operating-income guidance, Mr. Olsavsky said: an accounting change in how the company distributes its Prime subscription revenue, and an increase in wages for nearly 400,000 U.S. and U.K.-based blue collar workers. Amazon may also face greater unpredictability as it handles more of its own package deliveries, he said, which could result in too much or too little capacity. Fuel-price fluctuations could likewise increase uncertainty.
“We’re expecting a strong holiday season, so there’s no message in our forward guidance against that,” Mr. Olsavsky added.
Amazon’s increased compensation expenses stem from the company’s decision to raise its minimum wage for warehouse and customer service workers to $15. That is expected to cost the company $3 billion next year, Morgan Stanley analysts have projected.
Amazon increased pay in part to address criticism from politicians including Sen. Bernie Sanders, who recently introduced a bill called the BEZOS Act aimed at taxing big companies whose employees rely on federal benefits to make ends meet. Mr. Sanders praised Amazon’s wage rise, calling it a possible “shot heard around the world.”
Mr. Olsavsky also stressed several measures the company has taken to reduce costs, including pulling back on hiring in some areas. The number of employees grew roughly 13% year-over-year through October to 613,300, compared with 38% growth the prior year, excluding Whole Foods.
“We’re continuing to invest in a lot of areas,” he said. “We’ve also purposefully looked for areas where we can hold head count flat.” In addition, the company has slowed down its rapid growth of warehouse and data-center capacity, helping to control costs this year.
Some investors don’t seem worried by Amazon’s slowing revenue growth, as they’ve benefited from the run-up in share price. “There’s no doubt this team has been able to execute very well,” said Maz Jadallah, CEO of AlphaClone, which owns Amazon stock in the firm’s exchange-traded fund. He said his firm was pleased with this quarter’s growth and will keep an eye on the holiday period to see what happens.
U.S. Economy Flashes Signs It’s Downhill From Here
A slowdown in growth would have big implications for stocks, the Fed and President Trump.
What if that was as good as it gets?
The Commerce Department reported Friday that U.S. gross domestic product expanded at a 3.5% annual rate in the third quarter.
Coming off a 4.2% growth rate in the second quarter, it marked one of the best six-month stretches for the U.S. economy in the past decade.
However, private analysts and the Federal Reserve say a slowdown is looming. Economists surveyed by The Wall Street Journal estimate the growth rate will slow to 2.5% by the first quarter of next year and 2.3% by the third quarter of 2019. The Fed is expecting growth to slow further to a 1.8% rate by 2021.
“We think U.S. growth may have just peaked,” said Michael Gapen, chief U.S. economist for Barclays Capital, who is in Wall Street’s big-slowdown camp.
Few believe a recession is near, and the expansion is widely expected to become the longest on record next year.
Still, a slowdown in growth would have big implications for stocks, the central bank and President Trump. The White House says faster growth is evidence that tax cuts and its deregulatory stance are working, and that the growth acceleration they produced are sustainable.
Mr. Gapen said two big drivers of growth this year—consumers and government spending—will slow in the months ahead. Consumer spending has picked up, thanks to tax cuts. He says the spending impetus from income-tax cuts tends to be greatest in the first two quarters after they’re enacted, and then fades over about eight quarters.
Thus consumer-spending growth, which hit a robust 4% annual rate in the third quarter, should slow in the months ahead, though he said strong household saving and low unemployment will prevent a sharp drop-off.
In February, the White House and Congress agreed to increase federal government spending by $300 billion above earlier spending caps. That will propel government spending for several more months, boosting growth, but the budget agreement runs out next September. That means its impact, too, will fade, unless the next Congress agrees to more.
Mr. Gapen noted that the big wild card for growth is business investment. Business tax cuts are meant to increase investment in software, plants and equipment, boosting the economy’s growth rate now and its potential to grow far into the future.
The White House projection of sustained 3% growth hinges on a business-investment boom. It looked like that was happening early in the year. Business investment grew at an 11.5% rate in the first quarter, with gains across many categories, including machines, intellectual property and big structures. But it has faded since, registering just 0.8% growth in the third quarter. That includes a drop in investment in structures such as oil-and-gas rigs, which had been a big driver of growth.
“That’s a worry, particularly after (businesses) got a nice big check from Uncle Sam,” said Beth Ann Bovino, an economist at S&P Global Ratings.
For the White House forecast to play out, business investment would have to rebound. A lower corporate tax rate—down to 21% from 35%—might help. But uncertainty about U.S. trade disputes with China and others might be making business executives wary about proceeding aggressively with new projects.
“The economy is still strong other than some of this noise introduced by the trade tariffs and whatnot,” said Douglas Waggoner, chief executive of freight broker Echo Global Logistics Inc., during an earnings call Wednesday. “We don’t really have a read whether this is just a temporary glitch or a start of a trend.”
The investment picture matters immensely for the Fed as well. If businesses plow money into new software and machines, it increases the chances worker productivity will rise, allowing the economy to grow faster without causing inflation. Stronger productivity would take pressure off the central bank to keep raising interest rates.
Without follow-through on business investment, the U.S. could face a different outcome: less growth and more inflation that requires the Fed to keep pushing rates higher.
Interest rate-sensitive sectors already show signs of wobbling. Home building has contracted in five of the past six quarters. Moreover, a stronger dollar, which raises the cost of exports to foreign buyers, could weigh on U.S. trade.
Why has the stock market stumbled of late? Mr. Gapen said investors appear to be sniffing out the slowdown that economists have been calling for several months. While earnings growth was strong in the third quarter, and many analysts still expect double-digit earnings growth through next year, some executives sound wary.
Garbage-hauling and recycling company Waste Management Inc. said Thursday that net income was up 29% from a year earlier in the third quarter, but Devina Rankin, chief financial officer, said “the economy is probably at a peak.”
“There’s definitely some room to go from here,” she said. “But we talked about the length of growth in this economy and the expectation that it could turn from here.”
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