How the Trade War is Stifling Capex and Margins

The U.S.-China trade war is becoming an increasing matter of concern for S&P 500 companies, judging by 2Q 2019 earnings calls. An increasing number are mentioning China growth trends in their calls, with almost half these mentions being negative, up from less than 30% being negative in 1Q 2019, Bank of America reports. Additionally, about 15% of the companies reporting so far have mentioned negative impacts from tariffs, compared to about 10% in the first quarter.

Moreover, during the first half of 2019, corporate capital expenditures (capex) have been growing at the lowest rate in the last two years. “With no trade truce in sight and macro data (particularly in manufacturing/industrials) continuing to surprise to the downside, the uncertainty overhang may continue to impact business spending,” BofA writes.

Excluding the financial sector, the average net profit margin for the S&P 500 is coming in at 10.9% for 2Q 2019, down by 60 basis points from the same period in 2018, BofA reports. So far, about 90% of the S&P 500 companies have issued 2Q 2019 earnings reports. Margin compression has been most pronounced in sectors that have the most exposure to trade or which are the most labor intensive, including materials, information technology, industrials, and consumer discretionary, BofA adds.

Regarding capital expenditures, 2Q 2019 results are showing year-over-year (YOY) growth of about 3%, roughly in line with the 1Q 2019 YOY growth rate, the lowest since 2Q 2017, per BofA. Based on their analysis of corporate guidance on capex, BofA sees trade-related uncertainties continuing to restrain spending plans.

There has been an increase of 41% in the number of S&P 500 companies mentioning tariffs in their earnings calls, FactSet Research Systems reports. Their study compared the 419 first quarter 2019 earnings calls that occurred between March 15 and May 8 with the 438 second quarter 2019 earnings calls that took place between June 15 and Aug. 8. During these periods, the number of companies discussing tariffs rose from 88 (21% of 419) in 1Q calls to 124 (28% of 438) in 2Q calls.

In the 2Q 2019 calls analyzed by FactSet, companies in the industrials sector have discussed tariffs the most, accounting for 35 of the 124 mentions. The information technology sector has seen the biggest increase in the number of tariff mentions from 1Q to 2Q, up by 11 companies.

Nonetheless, tariffs were an even more prevalent topic of discussion a year ago, in earnings calls related to 2Q 2018 results. Between June 15 and Aug. 8, 2018, there were 426 calls, and 162 of them (38%) mentioned tariffs, FactSet notes.

President Trump’s recent decision to levy a 10% tariff on an additional $300 billion of annual imports from China is likely to weigh heavily on consumer discretionary stocks, BofA warns. More generally, FactSet notes that 84 S&P 500 companies have issued EPS guidance for 3Q 2019, with negative guidance coming from 60 of them (71%). Negative guidance is a corporate forecast that is below the then-current consensus estimate from analysts.

Over the past 5 years, 70% of corporate guidance has been negative, FactSet notes. The current consensus estimates for 3Q 2019 call for an S&P 500 earnings decline of 3.1% YOY and a revenue increase of 3.0%, they add.