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Drama lurks beneath earnings season's double-digit growth

Scott Gamm
Reporter
Trader Peter Tuchman works on the floor of the New York Stock Exchange, Tuesday, Oct. 2, 2018. (AP Photo/Richard Drew)

Double-digit earnings growth is set to continue for the third quarter reporting season, which unofficially begins Friday, but drama lurks in 2019 commentary. 

That’s because the 19.2% year-over-year earnings growth that S&P 500 (^GSPC) companies are expected to report, according to FactSet, may not be enough to trump the cocktail of challenges facing companies now and in 2019, including tariffs and wage growth.

“Some firms have already discussed the potential impacts [from tariffs],” said Goldman Sachs equity analysts, led by chief U.S. equity strategist David Kostin, in a note to clients. “For instance, Micron Technology MU reported that gross margins for upcoming quarters will be pressured by the imposition of the 10% tariff.”

While President Trump has calmed trade tensions with Canada, Mexico and the European Union, negotiations with China are ongoing and a big question mark for investors.

UBS analysts expect a 2%-4% impact on 2019 earnings from trade headwinds. That comes on top of already muted expectations for 2019 earnings growth of 10.2%.

Higher wages 

Aside from trade, wage growth poses a threat to margins.

Average hourly wages rose 2.8% over the past year as of September, according to the Bureau of Labor Statistics. While that was a slight decrease from the 2.9% growth seen in August, companies may have to start getting used to paying workers more.

And they may have Amazon to thank — it recently raised its minimum wage to $15 per hour, a far cry from the $7.25 national minimum.

Amazon’s decision has sparked a broader debate about companies hiking wages, according to Goldman Sachs analysts.

“Although this [Amazon] change will not impact the 3Q results of the S&P 500’s second largest employer, investors will be observing the responses from other firms,” the analysts added in their note.

Softening earnings

The one-two punch of tariff threats and rising wages come at a time when earnings growth is expected to soften.

The aforementioned 19% growth rate for the third quarter is down from the 25% clip seen in the first and second quarters. For the fourth quarter of 2018, analysts expect earnings to rise by a tamer 17.1%.

Before the “peak earnings” alarm rings, it’s important to note that even with the aforementioned headwinds, the underlying economy remains strong.

And that’s good for earnings, especially banks.

The first batch of results come Friday from JPMorgan Chase (JPM), Citigroup (C) and Wells Fargo (WFC).

Strong bank earnings could spark a positive halo effect for the rest of the season.

It’s often said that bank earnings set the tone for the rest of the season. And for good reason: these companies are highly levered to the economy.

“The ultimate driver of corporate sales growth is underlying economic activity,” Goldman Sachs analysts added.

Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.