Brexit fuels worries about expected US earnings recovery

World Today

EU and British flags are adjusted before the EU summit in Brussels, Belgium, June 28, 2016. REUTERS/Francois Lenoir

Foreign exchange volatility and economic uncertainty after Britain’s vote to leave the European Union have imperiled a projected profit rebound in the United States, where companies have been stuck in an earnings recession since last year.

U.S. companies doing business abroad are at particular risk because of a jump in the dollar since last week’s referendum and expectations of a potential stumble in European economies.

A strong dollar and plummeting oil prices slammed U.S. corporate earnings starting in 2015, but the stabilization of crude prices and the dollar in recent months has led investors to bet on a return to modest growth starting in the third quarter.

As the second-quarter reports gets underway in the coming weeks, executives’ comments about the so-called Brexit’s potential effects could alter Wall Street’s expectations of when the profit slump will end.

“This adds more fuel to the fire, that the so-called spurt in growth in the second-half of the year is going to be really tough to achieve,” said Synovus Trust Company Senior Portfolio Manager Daniel Morgan, who believes analysts are too optimistic.

This week, the average estimate for S&P 500 company third-quarter earnings edged down to 2.2 percent growth from 2.4 percent growth the day before the vote, according to Thomson Reuters data.

That could slip further as second-quarter reports get under way, which has been the case in recent history. Second-quarter earnings are forecast to decline 3.9 percent from a year ago.

Wells Fargo & Co (WFC.N), Citigroup (C.N) and JPMorgan Chase & Co (JPM.N) will be among the earliest U.S. heavyweights to post second-quarter results, all reporting in mid-July.

Some U.S. companies are already voicing caution about Brexit.

Cruise ship operator Carnival Corp (CCL.N) warned in its quarterly report on Tuesday that Britain’s withdrawal from the European Union could affect global consumer confidence.

Chief Financial Officer David Bernstein estimated on a conference call that weakness in the pound and euro would have an eight-cent impact on Carnival’s full-year earnings per share, although he said higher customer demand would make up for that and he did not reduce his outlook.

While Carnival and other multinationals rely heavily on Europe, including Molson Coors Brewing (TAP.N), which depends on Britain for a third of its sales, the exposure of most U.S. companies is limited.

S&P 500 corporations overall depend on Europe for 8 percent of their revenue, with just 1.9 percent of revenue flowing from Britain, according to S&P Dow Jones Indices.

And while some economists warn of a European recession, European Central Bank President Mario Draghi told EU leaders on Tuesday that Britain’s decision to leave the bloc could reduce euro zone growth by as much as 0.5 percent over the next three years. Earlier this month, the ECB said the euro zone would grow 1.6 percent in 2016 and 1.7 percent in 2017 and 2018.

For investors hoping improved profits would help push stock prices to record highs for the first time in 2016, Brexit has muddied the picture. The S&P 500 fell 5 percent following the vote, but has since regained most of that loss. It now trades at 16.6 times expected earnings, above its long-term average of about 15, according to Thomson Reuters data.

The recent slump in the euro and other currencies will affect companies dependent on foreign sales.

A U.S. dollar index .DXY is up 2.6 percent since Thursday’s close, although it remains down 2.7 percent for the year so far.

“That’s really the factor that we have to watch,” said Liz Ann Sonders, chief investment strategist at Charles Schwab & Co.

Helped by higher crude prices, earnings in the energy sector on average are seen falling 78 percent in the second quarter and then 54 percent in the following quarter.

Recovering oil and stronger foreign currencies versus the dollar this year, even following their recent Brexit-related losses, are key reasons to continue expecting an earnings recovery in the September quarter, said Brad McMillan, chief investment officer for Commonwealth Financial Network.

“We don’t need them to get better — although they are. We just need them to stop dropping,” McMillan said.

Story by the Reuters