This past holiday weekend, I read a book on beginner’s math to my toddler grandkids, titled “The Grapes of Math.” The book uses riddles to challenge kids to find patterns that help them count faster. For example: “How many grapes are on the vine? Counting each takes too much time. Never fear, I have a hunch, there is a match for every bunch.”

For adult investors, I’ve come up with my own math riddle: For the most recently completed quarter, corporate earnings are down but revenues are up. What gives?

To date for Q4 2019, the S&P 500 is posting a year-over-year decline in earnings per share (EPS) of -2.1%. Positive earnings surprises and upward revisions to EPS estimates posted by companies in the Health Care and Industrials sectors were offset by downward revisions to estimates for companies in the beleaguered Energy sector.

However, Q4 revenues for the S&P 500 are showing a year-over-year growth rate of 2.7%. Clearly, net profit margins are under pressure and that could bode badly for the rest of 2020.

According to research firm FactSet, the blended net profit margin for the S&P 500 for Q4 2019 is 10.7%. Blended combines actual results for companies that have reported and estimated results for companies that have yet to report.

If 10.7% turns out to be the actual net profit margin for Q4, it will mark the first time the index has reported four straight quarters of year-over-year declines in net profit margin since Q4 2008 through Q3 2009 (the time frame of the financial crash and Great Recession).

Among the 11 S&P 500 sectors, eight are reporting a year-over-year decline in their net profit margins in Q4 2019, led by the Energy (4.7% vs. 7.4%), Information Technology (21.4% vs. 22.7%), and Consumer Discretionary (5.9% vs. 7.0%) sectors. The following chart paints the picture:

Among the 74 companies in the S&P 500 that have already posted Q4 results, 67.6% have beaten consensus expectations.

The historically high percentage of companies that beat quarterly expectations seems impressive, but there’s a dirty secret on Wall Street. Corporate managers habitually low-ball forecasts, so they can more easily surpass estimates and ignite a spike in share prices.

Making investment decisions based on the earnings expectations game can be a risky proposition. In addition, the S&P 500 is probably overstating Q4 earnings because of stock buybacks and other financial engineering tactics. This year, the legerdemain is catching up with investors.

The sugar high is wearing off…

We’re also contending with a high baseline. In Q4 2018, the S&P 500 reported the fourth highest net profit margin (11.2%) since FactSet began tracking this data in 2008. Tax cuts were giving operating results a “sugar high” in 2018. But the tax cuts passed in 2017 no longer drive earnings growth, which means corporations will be more vulnerable this year to the synchronized slowdown in global economic growth.

Investors and corporations have pocketed their tax windfalls. By and large, the tax savings were not used by managers to invest in organic growth. The stimulus is over. What’s left is a massive federal deficit that will eventually boost interest rates.

Rising costs exacerbated by wage growth and tariffs are another reason for the earnings/revenue disconnect in Q4. Among the first 19 S&P 500 companies to conduct fourth-quarter earnings calls, six (32%) discussed higher inflation and input costs and five (26%) discussed higher wages and labor costs. Persistently low unemployment is putting upward pressure on wages, as employers compete for qualified workers.

Meanwhile, tariffs are tantamount to tax increases on companies. The transcripts of Q4 earnings calls so far reveal that tariffs are hurting the earnings of companies with greater overseas exposure, by increasing costs, lowering demand and squeezing profit margins. The slowing global economy also weighs on both the top and bottom lines.

And yet, stock valuations remain historically high. The forward price-to-earnings ratio of the S&P 500 currently hovers at 19.2, compared to the 10-year average of 14.6. The price-to-sales ratio of the S&P 500 recently reached 2.41, its highest level ever.

To justify significant stock price appreciation, we’ll need to see a big improvement in corporate earnings. We probably won’t get it.

Savor your gains from 2019, which was an exceptional year. This year, investing decisions will become a lot harder.

Auspicious beginnings…

That said, the January effect this year is alive and well. With the start of the new year, stocks came roaring out of the gate. Buoying stocks is investor optimism over the phase one trade pact between the U.S. and China that was signed on January 15.

Wall Street also is enthusiastic about the United States-Mexico-Canada Agreement, or USMCA, that replaces the NAFTA agreement that governs trade in North America. President Trump is scheduled to sign USMCA on January 29 during a ceremony at the White House.

Regular readers of my column know that I take a dim view of these two trade deals. Phase one is largely hollow and USMCA represents only modest tinkering with NAFTA.

Read This Story: The “Good Cop-Bad Cop” Trade War

On the economic front, the news is better. The U.S. Department of Labor reported Thursday that the number of Americans who applied for first-time unemployment benefits in mid-January rose slightly. However, layoffs remain at a 50-year low. Initial jobless claims only increased by 6,000 to 211,000 in the seven days ended January 18.

Investment moves to make now…

Amid these conditions, you should rotate toward defensive sectors, choose value over momentum, and keep plenty of cash (about 15%) on hand.

I’m especially bullish right now on utilities. As tariffs continue to harm multinational export-dependent companies, it’s important to remember that utilities derive zero revenue from China.

Utilities went on a tear in 2019. The benchmark Utility Select Sector SPDR (XLU) closed out the year with a return of 25.9%, just a few points behind the S&P 500. That’s exceptional, when you consider that utilities are safer than the broader market.

For our list of high-yielding utilities stocks that still trade at reasonable valuations, click here now. It’s no riddle that dividend-payers with robust balance sheets will survive the profit margin crunch of 2020.

John Persinos is the managing editor of Investing Daily. He also serves as managing editor of the premium trading service, Utility Forecaster. You can reach him at: mailbag@investingdaily.com