The third-quarter earnings season is officially upon us with J.P. Morgan Chase & Co. and Citigroup Inc. opening the floodgates early Thursday.
Earnings reports will again be closely monitored for signs that companies are performing well enough to support the repeated stock-market records registered this year. That was already the case in the second quarter, but it’s even more pressing this time around as stocks have rallied to fresh highs.
Investors can expect mention this quarter of some of the unusual and possibly one-off events of the last three months, including the three hurricanes that devastated parts of Texas, Florida and the Caribbean, also causing major damage in Puerto Rico.
Here are four things to watch for this earnings season:
In the eye of the storm
September was officially the most active month for hurricanes on record, according to the National Hurricane Center, and a wide range of companies from different sectors can be expected to discuss the impact on their business.
Already, the three major hurricanes, Harvey, Irma and Maria, have shown up in government data, including the September jobs report, which showed the workforce shrinking by 33,000 jobs, its first contraction in seven years.
Read: Consumer sentiment falls slightly in September amid hurricane concerns
Also: Hurricane Harvey slams industrial output in August
Airlines, insurers, retailers and energy companies are among the many sectors to have updated guidance to include some of the effects.
See also: Houston-based Francesca’s leads selloff of retailers with heavy exposure to storm-ravaged Texas
Zacks Research Director Sheraz Mian said the third-quarter season will likely have the lowest quarterly growth rate of 2017 after a round of estimate cuts. The finance and transportation sectors were the latest to be subjected to revisions.
“Earnings growth for the finance sector was barely in positive territory ahead of these insurance issues, but the hurricane season pushed the sector’s [third-quarter] earnings growth into negative territory,” he said.
The sector is now expected to see an 8.6% decline in earnings, with the brunt of the decline coming in insurance, which is expected to be down 45.1% from the year-earlier period.
Drug companies and medical-device companies that use Puerto Rico as a manufacturing base can be expected to update investors on their operations. Already, the Food and Drug Administration has warned of shortages of “critical lifesaving and life-sustaining drugs” as a result of the damage to the island caused by Irma and Maria.
Two drug makers have already offered an update on their PR operations. Amgen Inc. AMGN, -0.75% , which has manufacturing facilities in Puerto Rico and employs more than 2,000 individuals in the U.S. island territory, said it does not expect the hurricane to cause an interruption to drug supply, in part because it has maintained enough inventory to meet patient demand.
AbbVie Inc. ABBV, -0.35% said that its Puerto Rico manufacturing facilities were “intact and operational,” thanks to an independent power generator, and that it expects Hurricane Maria will have “no patient impact.” The company has 1,200 employees in Puerto Rico.
See: Hurricane Maria devastation in Puerto Rico could cause drug shortages elsewhere
Plus: What it takes to deliver a cancer therapy during a hurricane
Some companies are expected to benefit from the recovery effort, as soon as aid and insurance checks come through. Car makers already enjoyed a boost in September as consumers rushed to replace cars destroyed by storms. That trend is expected to gain momentum as insurance checks start to trickle out. Building-products companies and home-improvement retail chains can also expect demand to pick up as the recovery gains pace.
Read: Puerto Rico needs relief, and then major investments in its power grid
The Trump card
The inability of President Donald Trump’s administration to push through most of its agenda as party factions battle one another is expected to show up again this earnings season. In the second quarter, the failure to enact agenda items, including health-care reform, tax reform and trade policy, made it difficult for companies to make investment decisions, as was evident in the numbers.
Related: Trump executive order opens door to cheap insurance plans not subject to Obamacare coverage rules
S&P 500 companies generated a cash surplus of $60 billion, in contrast to the $22 billion deficit to investment spending recorded in the previous 12 months, according to J.P. Morgan data.
Strategist Dubravko Lakos-Bujas said that policy uncertainty was partly to blame for the subdued investment activity, alongside rich multiples and the rising cost of capital, as MarketWatch reported.
CFOs surveyed for Deloitte’s CFO Signals Survey pointed to U.S. political turmoil and geopolitical risks as the most worrisome external risks, and those factors are weighing on their minds even more heavily now than they did last quarter.
Political and geopolitical uncertainty has increased since the second quarter. The war of words between Trump and North Korean leader Kim Jong Un has intensified, while the separatist movement in Catalonia in Spain has resulted in a crackdown in Spain and rattled EU leaders.
Read: Mattis warns military to be ready if diplomacy fails with North Korea
Closer to home, Trump is talking of scrapping the North American Free Trade Agreement and negotiating separate deals with Canada and Mexico, creating new uncertainty. His all but unceasing Twitter rants against members of his own cabinet and party, his battle with the National Football league and attacks on the media have added to the sense of unease.
The effect of all this can be seen in Deloitte’s third-quarter CFO Signals Survey, a quarterly poll of companies in the U.S., Canada and Mexico with more than $1 billion in revenue, which was published in late September.
See: Finance chiefs are becoming increasingly pessimistic about the future
The survey found net optimism in their own companies tumbled to 29% in the third quarter from 44% in the second quarter. In the manufacturing sector, the decline was steeper, falling to 22% from 52% in the prior quarter, while the energy sector saw a decline to 19% from 48%.
“It is difficult to say what is behind these declining expectations, but CFOs’ list of most worrisome external risks seems to indicate that U.S. political turmoil and geopolitical risks are weighing even more than they did last quarter,” said the report.
See: Kim Jong Un calls Trump ‘mentally deranged’ and a ‘dotard,’ setting off scramble for dictionaries
One other measure of uncertainty is also flashing red. The Economic Policy Uncertainty Index, which was created in 2011 by academics from Stanford University, the University of Chicago and Northwestern University, is well above its long-term average. The index measures the frequency that words suggesting economic and political uncertainty appear in newspaper articles, as well as the spread between economic forecasts.
A higher reading usually foreshadows declines in investment, output and employment, according to the academics in a paper published in 2016.
The index stood at 155.6 in September, a full 37% above its 20-year average.
Weak dollar is making selling outside of America great again
S&P 500 companies can’t blame the dollar for any earnings or sales weakness anymore.
A Federal Reserve that is tightening monetary policy and stronger economic growth in the U.S. have acted as support for the dollar in the past, providing an easy excuse for multinational companies when profit and sales declined or missed their marks. Companies often use phrases such as “constant currency,” “organic” or “local currency” to give investors a better picture of results, without the negative impact of “currency translation.”
But during the third quarter, the average daily closing price of the ICE U.S. dollar index DXY, +0.15% , which measures the buck against a basket of rivals, stood at 93.439, or 2.4% below the daily average of the same period a year ago. And of the 63 trading sessions during the three months through Sept. 29, the dollar index closed below the year-ago average 57 times.
A lower dollar can help multinational companies, because it lowers the price of U.S. exports, making them more attractive for foreign consumers, and it also increases the dollar value of profits and sales made overseas.
So investors shouldn’t be too surprised if companies decide not to provide “constant currency” comparisons, which may be lower than actual results.
While a weaker dollar many help Wall Street and larger multinational companies, it’s not such a benefit to Main Street and smaller companies, as it makes products and raw materials from overseas more expensive.
From President Trump’s inauguration through the end of the third quarter, the dollar index had dropped 7.7%, while the S&P 500 index SPX, -0.17% climbed 11% and the S&P Small Cap 600 Index SML, -0.12% rose 9.2%.
The weaker dollar is also a reflection of accelerating economic growth outside the U.S. and the deceleration within, which should boost results of large-cap companies with more international exposure more than those with less.
The International Monetary Fund stated in its October world economic outlook that global economic activity is accelerating, as “upward revisions in the euro area, Japan, emerging Asia, emerging Europe and Russia more than offset downward revisions for the United States and the United Kingdom.”
For S&P 500 companies that generate more than half their sales inside the U.S., aggregate earnings are expected to decline 0.1%, according to FactSet data. For those that get most of their sales outside the U.S., the earnings growth rate is 7.9%.
Meanwhile, sales growth is expected to be 3.8% for companies with more sales inside America, and 7.7% for companies with more sales outside of America, according to FactSet.
Cybersecurity may be avoided, unless it’s useful
Another issue that companies may or may not bring up, depending on whether it’s useful, is cybersecurity.
The massive data breach at credit reporting company Equifax Inc. EFX, -1.53% during the third quarter, in which about two-thirds of the adult U.S. population and many corporate customers were affected, will likely be on investors’ minds when companies report earnings and outlooks.
Don’t miss: What to do now if you’re among 143 million Americans affected by Equifax data breach.
But if the first reports are any indication, companies may try to avoid the subject, until they are asked about it by Wall Street analysts.
J.P. Morgan Chase & Co.’s JPM, -0.88% earnings release, which kicked off earnings-report season before Thursday’s open, made no mention of the potential impact of Equifax’s data breach. After being asked by Morgan Stanley analyst Betsy Graseck during the post-earnings conference call whether the breach was driving any changes in assessing credit requests, Chief Financial Officer Marianne Lake’s response, according to a transcript of the call provided by FactSet, was less than clear or detailed:
|Yeah. So, I mean, I think the way to think about it, not to sort of diminish the importance of an individual breach or situation is that we are, honestly, under constant attack, both in a more general side of it, but also from a fraud perspective. And so while we always react and learn lessons from every individual situation, this is not the first breach, nor will it be the last breach.|
Also read: J.P. Morgan’s profit buoyed by lending.
Citigroup Inc. C, -3.43% , which also reported quarterly results Thursday, didn’t mention the potential impact of the Equifax breach until once again Graseck asked about it on the earnings call, given the companies’ partnership. CFO John Gerspach’s response, according to a FactSet transcript:
|We do use the services of Equifax, but we’ve got to say that while this one is a significant magnitude, data breaches aren’t new, and us having to work with and work around data breaches, I think for us and others is set to become fairly embedded in our business.|
See also: Citigroup’s earnings buoyed by retail bank.
That said, companies may become more willing to mention the negative effects, if it helps explain any disappointment. Some companies may also point out the rapid rise of cyberinsurance costs, as they provide profit or margin outlooks that may disappoint some investors.
The S&P 500 has gained about 14% in 2017, while the Dow Jones Industrial Average DJIA, -0.14% has gained about 15%.
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