Expectations for a strong third-quarter earnings season for companies in the S&P 500 index have been declining in recent weeks, despite favorable global economic conditions and what had been a weaker U.S. dollar, which favors companies within the index that derive a good bulk of their revenues from overseas operations.
Until Hurricanes Harvey and Irma hit Texas and Florida, the estimated earnings growth rate for the S&P 500 was about 5.0%. But since early September, analysts have trimmed those figures and are projecting earnings growth of only about 2.8% as of October 6, according to FactSet. Pulling down the aggregate earnings for the S&P 500 has been insurance and reinsurance companies.
Insurers and reinsurers (reinsurers sell insurance to insurers to offset their costs from major catastrophic events), have experienced only moderate losses from natural disasters in recent years. But with Harvey, Irma and Nate, earthquakes in Mexico and wildfires in California, the industry could experience its first hit to capital since 2005.
The insurance and reinsurance companies within the S&P 500 are also expected to push down year-over-year earnings for financial companies within the S&P 500 by about 7.8%. Given that the insurance sector’s earnings are estimated to fall by 51%, financial firms are expected to report the highest year-over-year declines among all of the S&P 500’s industry groups, according to FactSet. Without the insurance industry, estimated earnings for the financial companies would increase to 3.5%.
Insurers and reinsurers could have some leverage in the coming quarters, though, in that they may be able to push through significant price increases for U.S. natural catastrophe coverage. That is something they haven’t been able to do in a material way since Hurricanes Katrina, Rita and Wilma in 2005.
Potentially undermining the industry’s pricing power and transition to a so-called “hard” market will depend on how significant 2017’s natural disaster losses are to industry surplus – the funds set aside to pay claims. There is also alternative capital that has entered the industry in recent years from pension funds, private equity and insurance-linked securities that may also weigh on the transition from a soft to hard market.
Weaker Dollar, Stronger Earnings?
More upbeat earnings news may derive from those companies in the S&P 500 which may benefit from a weaker dollar and the uptick in global growth that’s been occurring during the past several quarters. In late September, the Organisation for Economic Co-operation and Development (OECD) projected that the global economy would grow by 3.5% in 2017 and by 3.7% in 2018.
A weaker dollar, meanwhile, helps translate companies’ foreign sales into more dollars for their earnings. The U.S. Dollar Index fell by another 2.7% during the third quarter and was down by 8.9% year-to-date through September.
Companies within the S&P 500 that generate less than 50% of sales in the U.S. are expected to post a 7.9% earnings growth rate for the third quarter. For those companies within the index that generate more than 50% of sales in the U.S. a slight earnings decline (0.1) is expected, according to FactSet.
Driving the estimates for outperformance for S&P 500 companies with more global exposure are the information technology and energy sectors. Excluding these two sectors, the earnings growth rate for companies that derive less than 50% of sales inside the U.S. would only be 0.7%, according to FactSet.
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