U.S. Stock Rally Sputters in Week as S&P 500 Profit Outlook Dims

  • Corporate earnings projections negative for third quarter
  • Losses in utilities, phone companies weigh on S&P 500
Photographer: Michael Nagle/Bloomberg

A two-month advance in U.S. equities ran out of steam amid signs investors are again growing skeptical of the long-awaited rebound in corporate profits.

Stocks didn’t fall by much -- at its close of 2,183.87, the S&P 500 Index slipped 0.01 percent over the five days -- but that was enough to make it the second-worst week since June. The benchmark gauge for American equity closed just 10 points above where it ended July as momentum seeped out of a rally that lifted shares almost 20 percent since February’s low.

Among reasons for the paralysis -- inflated valuations, the coming presidential elections, August vacations -- the most worrying may be the steady deterioration of earnings estimates for the second half of the year. Wall Street analysts are now projecting income for companies in the S&P 500 will decline in the third quarter by 0.9 percent, compared with 0.8 percent a week ago and estimates for an increase of 2.3 percent back in June.

Also of concern: equities faltered even as the outlook for interest-rate hikes stayed muted and signs of investor bullishness emerged. Anwiti Bahuguna, a senior portfolio manager at Columbia Threadneedle Investments, sees the souring profit picture as evidence the conditions that sent equities into a tailspin 12 months ago have yet to exhaust their impact.

“The tightening of financial conditions we saw last year -- dollar tightening, credit spreads blown out -- all of that takes time to work through the system, and still is working through,” Bahuguna, who oversees about $70 billion, said by phone. “Economic weakness translates into weakness in activity, which detracts from profits.”

The S&P 500’s decline came as global stocks dropped 0.2 percent for the week, falling for the second time this month. The Dow Jones Industrial Average lost 23.9 points to 18,552.57, leaving it about 83 points from an all-time high. The Nasdaq Composite Index added 0.1 percent to 5,238.38.

Stocks are still up more than 9 percent since the two-day selloff that followed the U.K.’s vote to separate from the European Union. The rally has been aided by economic data in the U.S. that has on average beat expectations as well as speculation the Federal Reserve won’t raise rates more than once in 2016, if at all.

While most companies beat expectations for earnings in the second quarter, a full-blown rebound in corporate profits in the second half of the year is looking like a taller order. Estimates for third-quarter earnings growth, as high as 10 percent at the end of 2015, turned negative in the first week of August, data compiled by Bloomberg show.

With 96 percent of companies reporting for the April-June period, profits contracted 3.7 percent from a year ago, according data compiled by Bloomberg. Revenue declined 0.2 percent. Income has now fallen for five straight quarters, the longest stretch since the financial crisis.

“Analysts and companies are continuing to be forced to lower those expectations to create estimates that they can actually beat,” Peter Andersen, chief investment officer at Fiduciary Trust Co. in Boston, said by phone. “Right now, they have the difficult job of managing expectations of a bounce-back, while producing estimates that they’ll ultimately be able to beat.”

There have been scattered signs of improvement in profits all year. Looking at the rate earnings are falling year-over-year, declines in the S&P 500 “appear to have troughed” during the first quarter of 2016, Brian Belski, chief investment strategist at BMO Capital Markets, wrote in a report to clients Friday. The number of companies with weakening profits was smaller this quarter than in the first, data compiled by Bloomberg show. So far, 37 percent of S&P 500 members reported lower earnings, compared with 39 percent last quarter.

Even with the outlook softening, signs abound that investors don’t want to miss the rally in equities. Hedge funds have raised net equity holdings in the past three months, and asset managers are favoring stocks over U.S. Treasuries, according to a report by Bank of America Corp.

Phone companies and utility stocks weighed on the S&P 500 in the week, extending losses in the two groups over the past month. While those sectors led the market higher in the first half of the year as investors sought dividends and perceived “safety” shares, investors have turned to technology and financial stocks since July.

Energy producers posted the biggest gains over the five days, adding 2 percent amid a 9.1 percent rally in New York-traded crude oil. The commodity is up more than 20 percent since Aug. 2, meeting the standard definition of a bull market.

“There continues to be widespread concerns about the U.S. and global economic recoveries,” Jim Paulsen, chief investment strategist at Wells Capital Management, wrote in a note to clients Friday. “Globally, Brexit concerns are lingering and U.S. investors still remain anxious about U.S. company earnings results and very weak U.S. real GDP reports during the first half of this year.”

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