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A weakening profit outlook is the latest worry for the S&P 500

Cook up whatever narrative you want for the stock market, in the end it will come down to earnings.

[NEW YORK] Cook up whatever narrative you want for the stock market, in the end it will come down to earnings. And that's a story that has been gradually getting darker.

In the latest twist, analysts have trimmed forecasts for S&P 500 profits in the fourth quarter to US$41.58 a share from US$42.66 two months ago. The 2.5 per cent reduction is the most at this point in a quarter since early 2017, data compiled by Bloomberg show.

While the paring isn't huge, it's something new for investors, who have enjoyed mostly upward estimate revisions ever since Donald Trump was elected president. For bulls, the question is whether the cuts are a predicable easing in an outlook that remains robust despite the Federal Reserve and tariffs - or the start of something bigger.

"When it comes to trade and the Fed, the key is that you have a market that's concerned about the next move - where is earnings and growth going from here?" said Bryan Besecker, an investment strategist at BNY Mellon. "We're still strong and positive, but it's just that the new direction is lower."

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By any reckoning, companies will do well this quarter. Even after the cuts, profits are expected to increase 14 per cent from a year earlier, which would be double the five-year average. But for investors besieged by a wave of negative macro headlines, the reduction underlines their fear that stocks may not be as cheap as they look and the high point of this earnings cycle has passed.

Equity valuations have come down a lot from the euphoric peak in January, courtesy of the second S&P 500 correction of the year. At about 15 times forecast earnings over 12 months, the index was traded at the lowest multiple in almost three years.

Does that make it a bargain? Depends on how reliable forecasts turn out to be. Prognosticators are becoming less sanguine. The expected rate of growth for S&P 500 income in the current quarter has fallen to 14 per cent from 18 per cent at the start of October. Almost all major industries have experienced downgrades, with materials producers, consumer discretionary and banks seeing their growth rates trimmed by at least 5.4 percentage points.

Expectations for next year are also weakening. At US$175.2 a share, estimated 2019 profits have declined 1 per cent from the peak in September.

Using history as a guide, more downgrades may be on the way. Thanks to tax cuts, 2018 stands as an exception, a year in which profits estimates have kept rising as it went on. That's not what usually happens. Over the last 30 years, analysts have generally started way too optimistic and then cut annual forecasts as time passes - by an average of 8 per cent, data compiled by Goldman Sachs showed.

Should 2019 track that pattern, EPS would erode to about US$161. That leaves the S&P 500 at 16.3 times earnings, based on its recent levels, roughly in line with the average multiple over the past five years.

On the bright side, the downward revisions are setting up a lower bar for companies to clear when earnings season starts next month. But Mike Wilson, chief US equity strategist at Morgan Stanley, isn't convinced that that'd bring good news. On the contrary, it's more likely to validate his call that there is a 50 per cent chance for S&P 500 companies to report two consecutive quarters of profit declines next year.

"We don't think the market will price that in until there is more hard evidence. Such evidence isn't likely come until next earnings season," Mr Wilson wrote in a note earlier this week. For the market, "it's likely to be an even choppier ride," he said.