Amid Earnings Declines, Corporate America Sees Signs of Profit Growth
Corporate America is starting to see signs of profit growth after a period of earnings declines, indicating a potential turning point for businesses. While the S&P 500 Index is on track to record a third consecutive quarter of profit declines, there are positive indications for the future. Profit growth, excluding the energy sector, is expected to return in the current quarter, according to Bloomberg Intelligence data.
Optimism is now returning to corporate boardrooms as economic data continues to show a resilient economy capable of supporting further growth. The Federal Reserve’s forecast no longer predicts that their aggressive tightening will push the economy into a recession. Additionally, major financial institutions, such as JPMorgan Chase & Co. and Bank of America Corp., have reduced their warnings of an impending downturn. Profit forecasts from companies like Royal Caribbean Cruises Ltd. and Coca-Cola Co. also suggest that the American consumer is still willing to spend.
According to Jimmy Lee, the CEO of The Wealth Consulting Group, as long as inflation continues to ease and the Federal Reserve maintains looser policies than expected, a recession may be avoided in the coming quarters. Companies are effectively navigating a high-interest-rate environment and managing strong wage growth, countering concerns about an economic slowdown.
A return to profit growth would provide much-needed support for US equities, following a relatively challenging second quarter. The current projected 7% profit contraction would be the most significant decline since the pandemic bear market. However, despite many companies surpassing expectations, investors remain unimpressed. Since the start of the earnings season on July 14, the benchmark equities index has only increased by 0.7%, despite a year-to-date increase of 17%.
Key takeaways from second-quarter results include the fact that companies that exceeded expectations on both earnings per share and sales experienced modest outperformance of the S&P 500 Index, signaling that investors were slightly less impressed compared to the previous six years. However, those that fell short of expectations underperformed the market less compared to the previous quarter. Specific companies like Arista Networks Inc. and Align Technology Inc. experienced the most upside price returns, while companies like DXC Technology Co and Generac Holdings Inc. were penalized.
Conversations about inflation, supply chains, and labor on corporate earnings calls are rapidly declining as pricing pressures become more moderate. In contrast, discussions about recession and layoffs seem to have reached their peak. Artificial intelligence and inventory destocking have emerged as major themes, reaching new highs, while pricing optimism is starting to fade.
Wall Street is adopting a more positive view of operating margins, a key profitability indicator that often predicts future stock performance. The consensus forecast expects operating margins to have bottomed out in the fourth quarter of 2022 after companies faced inventory overhangs, supply chain disruptions, and rising costs during the pandemic. However, cost-cutting efforts are expected to lead to significant margin improvements in the technology and communication-services sectors in the second half of 2023, while staples and healthcare sectors may struggle.
US companies are diverting cash from share buybacks to investments in their businesses, demonstrating confidence in their financial outlook and the overall economy. Last quarter, the median company increased capital expenditures by 15%, with three-quarters announcing programs that surpassed analyst estimates, according to data from Bank of America Corp.
Analysts are revising profit forecasts for the coming year positively, outpacing downward revisions. The indicator known as earnings-revision momentum for the S&P 500, which measures the overall direction of these revisions, has seen the most significant increase since May. At the sector level, industrials and discretionary sectors, which are closely tied to the economy, are leading the positive revisions, while energy, materials, and staples are still experiencing negative revisions.
