With a clearer line of sight on interest rates and inflation, earnings may increasingly become the swing factor for the direction of stock markets. Investors are asking whether they can hold up in the face of sliding economic data, or whether they will slide on the back of higher costs and weaker growth. As the US enters its first round of earnings announcements of 2023, the picture is decidedly mixed.
Few expected earnings to be buoyant, with most fund managers focused on assessing the extent of the decline. At the end of last year, there had been some stabilisation in earnings, but this had mostly come from energy-related sectors, such as oil and gas and utilities, which had flattered the aggregate numbers.
Zehrid Osmani, manager of the Martin Currie Global Portfolio Trust, said: “If you X-out those sectors, the picture remains very weak and there have been ongoing earnings disappointments. We predict more of those earnings disappointments with the fourth quarter results season, particularly in the more cyclical parts of the market.”
Osmani says, at the start of the year, the consensus of world earnings growth was around 3%. He believes this is likely to drop to around zero. The US could see a more significant drop, but from a higher base, so from 4-5% to -1%. In Europe, earnings could fall by -5%, some way from the current consensus that earnings will be flat.
These predictions appear to be coming to fruition, with notable weakness among the technology and consumer giants for the fourth quarter in results released last week. The dominant players in the cloud market – Amazon and Microsoft – saw growth slow, while smaller rival Google also saw cloud adoption fall to pre-pandemic lows. It shows a new reluctance from their corporate customers to spend money on digitisation. This had been thought to be one of the most resilient areas of technology spending and its weakness is a concern.
Even Teflon-coated Apple also showed weakness, with the smartphone giant missing analyst estimates on both revenues and profitability. It blamed the strong dollar, and continued production issues in China, but also the broader macroeconomic environment, which had impacted demand. That said, it maintained its high margins, which was welcomed by analysts such as Morgan Stanley.
The weakness of these behemoths is unwelcome, but technology was always likely to be in the vanguard of corporate earnings weakness. While it is not as cyclical as it was a decade ago, it is still exposed to consumer spending (Apple, Amazon) or corporate spending (Microsoft, the cloud providers). The worry is that weakness emerges elsewhere.
Overall, at this halfway point in the season, S&P 500 earnings are in line to fall 2.7% for the fourth quarter, according to data from Refinitiv. There is concern that the trends seen for the big technology names may be replicated for the streaming services or gaming companies. At the same time, companies that had been beneficiaries of rising inflation, such as food groups, may see earnings fall as prices slowly return to normal.
Lewis Grant, senior portfolio manager, global equities at Federated Hermes, says the corporate outlook is certainly weakening: “It is no surprise that the inflationary environment has proven challenging to corporate profitability, and expectations have reduced accordingly. However, the effects of inflation are proving more stubborn than anticipated, providing a sobering reminder that the economy is not as robust as we had hoped.
“Weak outlooks from prominent bell-weather companies are a red flag that should not be ignored. While price hikes have padded profits thus far, there are growing concerns that consumers and businesses alike are becoming increasingly cautious.” He says that the remainder of earnings season and the ability of central banks to navigate the delicate balance will be crucial.
Wage growth is increasingly becoming a key factor for corporate earnings. Wages are a significant input cost for the dominant services sector in the US. Osmani says that 80% of medium-term inflationary pressures come from wage inflation.
In this, the January jobs report from the US was unwelcome. Economists had been expecting a slowdown in growth – with just 187,000 jobs added to the economy versus 223,000 in December, plus growth in unemployment and an easing in wage increases. The waves of layoffs at the technology companies seemed to support these expectations. However, as it was, the economy added more than 500,000 jobs and unemployment dropped.
There are some anomalies in the data. January is a big adjustment month, and jobs data may lag rather than lead economic weakness. However, it is still likely to weigh on corporate earnings in the months ahead.
There was more positive news in the longer term. The annual Fidelity Analyst survey, which takes the pulse of analyst sentiment across the world, showed 60% of analysts believe their sectors are already in a slowdown, a shallow recession or worse, but just over half of those analysts expect the business cycle will have turned positive again by the end of 2023. Three quarters (74%) of analysts say their companies’ CEOs expect earnings to grow over the next 12 months, with particular optimism in the utilities, materials, information technology, and healthcare sectors.
Economic data rarely emerges in a straight line, but at the moment, it is particularly mixed. It is difficult to paint a good picture for corporate earnings, as wages rise and demand slows, but weakening inflationary pressures elsewhere may help. Equally, analysts are forecasting that earnings may start to reverse by the end of the year. However, investors may need to brace themselves for some pain in between.
