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The U.S. economy is humming and the unemployment rate has fallen to 50-year lows. But as the third-quarter reporting season gains momentum this week, some observers believe that tariffs, wage inflation and higher interest rates are going to pose serious challenges to the bull market in stocks.

“There are some pretty big speed bumps in the road ahead,” Lori Calvasina, head of U.S. equity strategy at RBC Dominion Securities, said in a note.

To be sure, the outlook for earnings is upbeat right now. Analysts expect that companies in the S&P 500 will report quarterly profits that are 21.5-per-cent higher than last year, according to Refinitiv, a former unit of Thomson Reuters now majority-owned by Blackstone Group LP. That’s impressive for an economic expansion that is more than nine years old, and is down only modestly from 25.8-per-cent growth in the second quarter.

Within the S&P 500, just 21 companies have reported their third-quarter results so far, or 4 per cent of the index. But it’s a promising start: More than 85 per cent of those companies have beaten analysts' expectations, which is well above the average beat rate of 64 per cent.

JPMorgan Chase & Co. and Wells Fargo & Co. will report their results on Friday, adding some detail to this early snapshot. And next week, the trickle of earnings reports will turn into a deluge, providing a far clearer look at the earnings trend.

This year’s U.S. tax cut continues to provide a powerful boost. According to Goldman Sachs, the lower tax rate added 10 percentage points of earnings growth in the first half of the year, and the lower rate could be the source of additional pleasant surprises if analysts continue to underestimate its impact on corporate profits.

Higher oil prices are helping as well. Analysts expect U.S. energy companies will see their profits more than double from last year’s third quarter.

At the same time, analysts expect that corporate sales will rise 7.4 per cent year-over-year, according to Refinitiv, suggesting that profits are being driven by more than government policy and commodities.

“The ultimate driver of corporate sales growth is underlying economic activity,” David Kostin, a strategist at Goldman Sachs, said in a note.

He pointed to the U.S. unemployment rate, which is down to just 3.7 per cent; the latest National Federation of Independent Businesses survey, which notched its best reading since the survey began 44 years ago; and the fact that the ISM non-manufacturing index touched its highest reading since the survey began in 1997.

“But all the current positive fundamental news also introduces risks for 2019,” Mr. Kostin added, noting that investors will be listening carefully to third-quarter earnings calls to learn more about how companies are addressing trade tariffs, rising wages and the Federal Reserve’s three interest rates hikes this year.

He thinks tariffs won’t have much of an impact on third-quarter results, given that most of the levies on Chinese goods weren’t imposed until late into the quarter. Theoretically, though, the impact could be big: If a 25-per-cent tariff were applied to all Chinese imports, it could eliminate all S&P 500 profit growth in 2019, Mr. Kostin warned.

What’s more, rising wages could compress profit margins and force companies to slash their earnings expectations. And rising interest rates are pushing borrowing costs higher, which will weigh on firms with heavy debt loads.

RBC’s Ms. Calvasina said that the earnings growth rate is set to decline toward single-digit growth in the first half of 2019 – a trend that often coincides with a weaker S&P 500.

She noted that companies have been trimming their expectations for the third quarter. And fourth-quarter profit growth now stands at an estimated 18.1 per cent, down from 18.5 per cent previously.

“Conditions are the same for revenue growth, with signs of a slowdown in the growth rate in place and further downward revisions underway,” Ms. Calvasina said in her note.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 28/03/24 4:15pm EDT.

SymbolName% changeLast
GS-N
Goldman Sachs Group
+0.59%417.69
WFC-N
Wells Fargo & Company
+0.61%57.96
BX-N
Blackstone Inc
+0.37%131.37
TRI-T
Thomson Reuters Corp
-0.41%210.8
TRI-N
Thomson Reuters Corp
-0.08%155.83

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