What Q4 Earnings Must Show for Stocks to Move Higher

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Of the many factors driving stocks, optimism about quarterly earnings is one of the most important. But the prime mover for stock prices right now may well be whether companies exceed earnings estimates for 2020.

Stocks have drifted higher of late. After 2019’s 27% gain in the S&P 500, stocks pushed through the concern of military conflict with Iran in January and focused on the probability of a phase-one trade deal between the U.S. and China. That was signed Wednesday.

Plus, better-than-expected economic growth is supported by the Federal Reserve’s clear continuation of low interest rates.

While valuations are excessive to some on Wall Street, they’re not out of control for other observers, with the average multiple on next year’s earnings within the S&P 500 sitting just under 19. And investors are holding plenty of cash, so any optimism on earnings will create demand for stocks.

But fourth-quarter earnings broadly are expected to decline roughly 2%.

“The key to this reporting season will be whether the optimistic growth outlook reflected in consensus earnings estimates for this year remains intact after companies issue guidance,” wrote LPL Financial Chief Investment Strategist John Lynch in a note.

"With valuations elevated, corporate America will probably have to do the heavy lifting to get stocks much above current levels.”

Analysts polled by FactSet are now looking for full-year 2020 earnings growth of more than 6%. But some analysts say that estimate might be conservative.

For one thing, the National Retail Federation said holiday sales rose 4.1% year-over-year, at the high end of its estimate of 3.8% to 4.2%. Strong consumer spend has underpinned the U.S. economy. (Lululemon LULU and Abercrombie & Fitch ANF are two retailers particularly poised to benefit, analysts say.)

Also providing a supportive backdrop to 2020 earnings is the trade deal.

Tariffs on some goods coming into the U.S. from China were halved to 7.5%. This removes a chunk of the cost of importing for U.S. companies, supporting gross margins. That eases pressure on companies that raised prices to protect their margins.

The timing of a phase two isn’t yet clear, but if the process continues, corporate executives might be inclined to invest more than they have.

A strong caveat: U.S. Treasury Secretary Steve Mnuchin said this week that we aren’t likely to see trade progress until after the November presidential election. That does not exactly boost business confidence and investment.