Welcome to earnings season, the six-week stretch when most US companies release their Q1 performance reports. For investors and other inquiring minds, these filings can serve as a look into how companies are doing and what management teams expect for the future.
More broadly, earnings season is like a vibe check for financial markets as a whole. Considering the struggling state of markets at the moment, one would think that bad vibes there equal bad vibes in Q1 reports.
However, if analyst forecasts are any indication, we may be underestimating just how well corporate America — and the economy — are doing.
We’re pleased to report…
While markets may be giving off feelings of doom and gloom, companies’ bottom lines may be holding up surprisingly well. So much so that Wall Street analysts have steadily raised their expectations for S&P 500 earnings since the beginning of March. Yes, even while the Russia-Ukraine conflict and Federal Reserve fears led to even more market volatility.
So why are the country’s top companies projected to outperform public perception, despite obvious headwinds? It’s largely due to less-publicized economic tailwinds in the US, namely: a flourishing job market, an excess of pandemic-fueled consumer savings (which can result in more consumer spending), and an increase in business investment (i.e. capital expenditures) among S&P 500 companies.
If you can connect the dots from above, S&P 500 companies are preparing for a spendy summer, while still investing in their businesses and hiring at a rapid pace. US businesses have hired more than 400,000 workers for 11 straight months, and there are still 1.9 job openings for every out-of-work person. Meanwhile, retailers have been stocking up inventories in preparation for increased spending and to ease supply chain concerns. And profit margins — sales minus operating expenses — are expected to stay unusually high, despite historic cost pressures.
Companies aren’t acting like there’s a recession around the corner. If that were the case, you’d expect to see them tightening their budgets and limiting costs. Instead, capital expenditures rose to a record $80.3 billion, according to Census Bureau data. It’s a strong sign for the economy’s future that companies feel comfortable re-investing. More business spending and better technology could eventually help ease the pain of labor shortages and inflated prices.
The fears
While some are reading the tea leaves in a positive manner, that doesn’t mean every company is feeling optimistic right now. For one, high-end stores are noticing some hesitation among their customer base. Retailers are just one of two sectors expected to show a year over year decline in profits in the first quarter, according to Bloomberg estimates. On March 29, the Restoration Hardware CEO made headlines when he compared the current environment to the early days of the Great Financial Crisis. Restoration Hardware stock fell 13% the next day.
There’s also some concern that companies’ free-wheeling could backfire if consumer spending starts to slow. Businesses may get caught up in what’s known as the bullwhip effect, in which they drastically overshoot customer demand just by tweaking their supply chains. In other words, what happens if companies prepare for feasts and we end up getting famine? If consumer spending slows, companies could be left with overstocked inventories and unmanageable costs.
Heed the (conference) call
Companies have been the underdogs of the recovery, and underestimating them has been a trend on Wall Street since COVID began. This season, corporate strength could help propel the market in trying times. After all, the S&P 500 has climbed in seven of the last eight earnings seasons (with last quarter being the outlier).
For now, the biggest question on Wall Street is just how dramatic the Fed’s plans and rising credit rates will impact consumer spending. In the meantime, it may be helpful to watch earnings reports of companies from various sectors, especially cyclical ones (like industrials, materials and real estate) that are especially sensitive to the economy’s ups and downs. What company executives say in this earnings season could give you a better sense of how they see their optimism and reality intersecting.
In the end, a market is made up of billions of shares of different companies. If those companies are thriving, no matter the reason, it’s tough to anticipate that the markets or economy as a whole could crumble. Just remember to always consider the risks and be prepared for the unexpected.
*Data sourced through Bloomberg. Can be made available upon request.