Dour earnings loom over Wall St. as a slowing economy bites

As the country’s biggest companies prepare to report their results for the start of the year – giving a glimpse of how the economy is faring as a banking shock reverberates – they are already warning investors to brace themselves.

For the large companies that make up the S&P 500 index, Wall Street forecasters expect profits in the first three months of 2023 to fall nearly 7 percent from a year earlier, according to estimates compiled by FactSet. It would be the second consecutive quarterly decline, and the biggest since a severe – but short-lived – recession in the early days of the coronavirus pandemic in 2020.

The warning marks a rapid deterioration of the forecasts. At the start of the year, it was agreed that the surplus would be roughly in line with the first quarter of 2022. But since then, continued concerns about inflation followed by a flare-up in the banking sector in March have dampened the outlook.

Companies have also told investors to dial back their expectations, with 78 companies in the S&P 500 offering guidance on their earnings that are below the average Wall Street estimate. It’s true that corporate executives often manage expectations so they can give investors a pleasant surprise rather than a nasty shock, but such low forecasts are rarely so widespread, suggesting there may be more to them this time, Rob Temple said , marketing strategist. at Lazard.

“We’re more likely to be disappointed than surprised on the upside,” he said.

Everyone wants to hear from the country’s big banks.

The first group to report results happens to be the industry that investors are most eager to hear from. Major banks including JPMorgan Chase, Citigroup and Wells Fargo will release their results on Friday, the first formal update for the industry since the collapse of Silicon Valley Bank last month.

Investors and analysts note that it is likely too early to see the full effect of March’s turmoil, given that it came so close to the end of the quarter. Instead, the focus will be on comments from the bank’s CEOs and CFOs about what they have seen recently, and what they can expect – both for the banks and for the economy.

“It’s going to be more about the comments and the tone,” Mr. Temple said.

A key question for investors will be how many customers have transferred their deposits from smaller regional lenders to the biggest lenders, and what financial steps smaller competitors have been forced to take to stay afloat.

There are already signs that banks have pulled back from lending, and that could put pressure on other companies that need cash as the economy weakens.

“These CFOs should be prepared to take the third degree and provide details on how they’re handling it and what things look like down the road,” said Michael Kushma, chief investment officer for broad market fixed income at Morgan Stanley Investment Management.

Elsewhere, profit margins will be a detail to watch.

As inflation rose last year, consumers were willing to pay higher prices that were passed on by companies that themselves faced higher costs. As a result, the company’s profit margins increased in 2022, to the highest level since 2008.

The Federal Reserve continued to raise interest rates in the first quarter, raising costs for companies and consumers. But companies are finding it increasingly difficult to continue raising prices on their customers.

For companies in the S&P 500, net profit margin, or the percentage of a company’s revenue that ends up as profit, is expected to fall to its lowest level since the end of 2020, FactSet data shows.

If companies can’t pass on costs as easily, they are likely to become more conservative in their decision-making, pull back on spending and potentially lay off workers, slowing the economy.

“We have lived with higher than normal interest rates for another three months, at a time when economic activity has slowed. What has been the effect of that?” said James Masserio, co-head of equities for the Americas at Société Générale. “It’s going to be front and center for people.”

While the overall expectation is a decline in profitability, the outlook for different sectors of the stock market varies widely.

Materials companies, such as miners and commodity producers, are expected to show their earnings have fallen by about a third from the start of 2022, according to the FactSet data, as fears of a slowdown in global growth have dampened demand for a range of commodities such as copper and aluminium.

Communication and technology companies are also expected to report sharp declines in earnings. At the other end of the spectrum, major oil producers such as Exxon Mobil and Chevron are expected to report double-digit earnings growth for the fifth straight quarter, and industrials for the eighth straight quarter, with global demand offsetting a price decline.

Delta Air Lines, one of the first major companies to report earnings, reflected a mixed outlook in its own results. The company said on Thursday that it had fallen short of forecasts for sales and earnings in the first quarter. But due to “record pre-orders for the summer,” it gave a bullish forecast for growth in the second quarter.

So far, the stock market is taking this in stride.

Despite the deteriorating outlook, share prices are holding up. The S&P 500 has moved sideways so far in April, but is up 7 percent for the year.

To some extent, that reflects the skewed composition of the index, with the colossal sizes of Apple, Microsoft and a handful of others meaning that gains in their share prices can prop up the index even when other companies falter.

The Russell 2000 index of smaller US companies, which are more vulnerable to an economic downturn, has fallen this month, but even that index remains positive for the year.

Some analysts and bankers said many investors had spent the past few months preparing for a more turbulent time ahead and were already positioned for the bad news. That can help support market prices even when weak earnings reports roll in.

That is the optimistic outlook. The counterargument is that – despite dire predictions about the economy and corporate profits last year – investors have not had to face a meaningful downturn. The new data could change that.

“That’s a big piece of the puzzle we’re missing,” Masserio said.

Rob Copeland contributed reporting.