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The CEOs of the world’s biggest companies left Davos on January 20 after a week of hungover good cheer. The mood at the annual gabfest was, if not optimistic, at least darker. Behind closed doors, CEOs conceded that while the war in Ukraine remains a humanitarian tragedy, the risks to the global economy seem contained for now. Central banks have taken inflation seriously. If a recession hits America and Europe, it should be manageable. The Chinese delegation has sent the clearest signal in years that China is not just reopening after its harsh zero-covid regime, but also reintegrating into the world. Globalization may not be at its best, but news of its demise has seemed, to snowswept bosses, over the top.
Back on earth, things seem more complicated. “Earnings season is going to be the faith event,” says Jim Tierney of AllianceBernstein, an investment firm, referring to the month or so when most companies release their quarterly results. Profits for the US banking giants, which started last week, fell 20% year-on-year. Investment bankers took a particularly severe beating as deals slumped amid economic uncertainty. In early January, Goldman Sachs gave the boot to about 3,200 of its employees.
Corporate America’s earnings estimates are plummeting more precipitously than a black ski slope. In the final three months of 2022, analysts revised their fourth-quarter earnings forecast for the S&P 500 index down 6.5%, twice the usual downward revision. The collective wisdom of Wall Street over the last quarter now points to a year-over-year decline in earnings, the first since the depths of the pandemic in 2020 (see chart 1).
For many businesses, costs are growing faster than sales. Companies are finding it more difficult to resist wage increases than to persuade customers to bear rising costs. This will squeeze margins at a pace that has yet to be fully digested by analysts, who still collectively predict earnings to rise in 2023. If the U.S. economy slips into a recession, as many economists predict, earnings will almost certainly drop even more. Since World War II, earnings per share have fallen by an average of 13% around periods of economic contraction, calculates Goldman Sachs.
The first thing companies will admit is consumer fatigue. On company conference calls with analysts late last year, many spoke of weak demand as shoppers limited their spending on discretionary items. Procter & Gamble, whose products range from diapers and detergents to dental floss, reported lower sales volumes across its businesses in the fourth quarter. It only managed to meet earnings expectations because it raised prices by 10% and forecasts further increases in February.
Yet the chorus of bosses announcing such “pricing power,” last year’s favorite boast, will be quieter this earnings season. Although households are still spending excess savings accumulated during the pandemic, they are increasingly bargain-hunting. U.S. consumers skimped on everything from restaurants to electronics in December, pushing retail sales down 1.1% on a seasonally adjusted basis from the previous month. Constellation Brands, which makes and distributes Corona beer for drinkers in America, said Jan. 5 that it expects slower price increases this year. Many retailers offer merchandise discounts to eliminate inventory. Tesla car prices are lower globally by up to 20%.
As demand falters, companies admit excessive costs – their second confession. Tech companies, which saw appetite for their products slow last year from earlier pandemic-induced highs, are doing so with particular zeal. Apple boss Tim Cook is taking a 40% pay cut this year. Twitter is auctioning its neon-bird wall art. Less symbolically, Microsoft announced on January 18 its intention to lay off 10,000 people. Two days later, Alphabet, Google’s parent company, said it would lay off 12,000. The cuts don’t entirely reverse the pandemic tech hiring spree, but a Silicon Venture investor Valley believes this will provide “air cover” for more tech companies to reduce payrolls and shore up cash flow.
The companies’ third admission concerns the fate of any profits that will be made. This earnings season is also an opportunity for companies to present their spending plans for the coming year. Overall, large U.S. corporations tend to split their spending evenly between payouts to shareholders (through dividends and stock buybacks) and investments (research and development, capital expenditures, and mergers and acquisitions). acquisitions).
In the era of cheap money, before central banks started raising interest rates to stifle inflation, payments were often financed with debt. Now that money is expensive, these borrowings should decrease. When it comes to deals, many acquirers are still sorting out the mess created by deals struck at record prices during the pandemic merger boom. Depreciations acknowledging the decline in value of some of them are more likely than announcements of reconstituted war chests and the desire to do more business.
Investments remain. The megatrends of the 21st century – decarbonization, digitalization and decoupling between China and the West – argue for gigantic spending on climate-friendly technologies, robots and software, and non-Chinese factories. A European industrial boss argues that, as a result, investment spending should weather the impending slowdown better than usual.
May be. For now, however, most companies remain cautious. After U.S. business capital spending rose in the third quarter of 2022, a corporate spending plan tracker compiled by Goldman Sachs indicates continued growth but at a considerably slower pace.
Many companies are likely to postpone major spending decisions until economic uncertainty lifts. Ericsson, a Swedish telecommunications equipment maker, warned that its US customers are increasingly delaying new network investments. Dell shipped nearly 40% fewer PCs, which it sells primarily to businesses, in the fourth quarter compared to a year earlier, according to IDC, a research firm. Logitech, which makes keyboards, webcams and other desktop-related hardware, now expects revenue to fall 15% in the fiscal year ending March, down from its previous estimate of no more than 8%. Software makers, like Microsoft, and chip makers, like Intel, could also be hit by reduced digitization budgets.
Like all earnings seasons, this one holds positive surprises. A few have already emerged. United Airlines has raised prices without putting off vacationers and business travelers. Netflix exceeded expectations by adding 7.7 million new subscribers in the fourth quarter, thanks in part to a cheaper, ad-disrupted new service. The beleaguered streaming service, which has lost around half of its market value since peaking in fall 2021, issued a bullish 2023 earnings forecast. On January 19, Reed Hastings stepped down as co-CEO of Netflix, perhaps because he thinks the worst is over for the company he founded 25 years ago.
Such perkyness will be the exception rather than the rule this year, however. Overall, positive earnings surprises have become less positive in recent quarters (see Chart 2). After hitting a record high as a percentage of GDP last year, after-tax corporate profits look set to correct. And they could still fall. High debt and low taxes, which propelled corporate profitability for decades, are no longer the tailwinds they were, as interest rates rise and the appetite for government-funded tax cuts deficit decreases. Real corporate life takes place at less rarefied levels than in the Swiss Alps.
© 2023 The Economist Newspaper Limited. All rights reserved.
From The Economist, published under licence. Original content can be found at https://www.economist.com/business/2023/01/22/big-business-is-in-for-a-rough-earnings-season
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