Weak Corporate Earnings Signal A Weak Economy (#GotBitcoin?)
Tepid results from multinationals don’t necessarily signal trouble at home. Weak Corporate Earnings Signal A Weak Economy (#GotBitcoin?)
American companies are reporting second-quarter results, and the numbers so far have been nothing to write home about. Based on current estimates compiled by FactSet, earnings for companies in the S&P 500 will be down 1.9% from a year earlier. Actual results probably will be somewhat better given companies’ tendency to lower the bar and then clear it, but the final figures are unlikely to fit anyone’s definition of good.
It is tempting to hang earnings weakness on the domestic economy. Even though growth has moderated a bit, it is still solid. Macroeconomic Advisers estimates imply that final sales to domestic purchasers—a measure of underlying economic demand—was up 2.6% from a year earlier in the second quarter. That compares with a 2.9% gain in the second quarter of last year.
Outside the U.S., things aren’t looking so rosy, and that is a problem for many of the companies in the S&P 500, which conduct a substantial share of their business overseas. Paint maker PPG Industries , for example, which generated more than half of its income outside the U.S. last year, highlighted weakness in the Chinese and European auto markets when it reported a 2.6% decline in second-quarter sales. The strength of the dollar compounds the problem: Industrial-equipment maker Dover said foreign exchange created a 2.6% headwind to sales.
Tariffs and trade tensions are another point of stress, particularly in the manufacturing sector.
The Federal Reserve’s beige book survey released Wednesday—a report of anecdotes drawn anonymously from business contacts around the country—showed manufacturers continuing to worry about the uncertainty and costs associated with the various trade disputes into which the U.S. has entered.
But trade counts as more of an issue for large public companies than for U.S. businesses at large. That isn’t just because of all the business they do overseas but also the kinds of companies they are. Some 190 of the 500 companies in the S&P 500—more than a third—are classified as manufacturers. Yet manufacturing jobs count for only 8% of U.S. employment.
Finally, companies are being confronted by rising labor costs and an inability to pass those costs on. It is part of why profit margins look to have slipped in the second quarter. But for most Americans, the combination of rising wage growth and low inflation probably counts as a good thing.
It is easy—and often makes sense—to view big U.S. companies as a barometer of the U.S. economy, but that is misleading at the moment.
A measure of something isn’t the same as the thing itself.
Squeeze on U.S. Companies May Be Worse Than It Seems
American firms are in worse shape than reported earnings indicate.
U.S. companies might be feeling a lot more pinched than they appear. That could have serious repercussions for both the stock market and the economy.
Earnings season is about to get under way, and it looks as if the news won’t be good. Analysts polled by FactSet estimate that earnings per share for companies in the S&P 500 fell by 4.1% in the third quarter from a year earlier. Even with the allowance that actual results probably won’t be quite as bad, since the bulk of companies usually top estimates, it looks as if it will mark the third quarter in a row that earnings slumped.
It is a comedown from last year when, buoyed by a strengthening economy and corporate tax cuts, earnings grew by 20%. Trade tensions and slower economic growth are weighing on sales, while rising labor costs are cutting into bottom lines. The net profit margin for the S&P 500—income as a share of sales—fell to an estimated 11.3% in the third quarter from 12% a year earlier, according to FactSet.
Margin pressures are more than just a problem for shareholders. Because they drive companies to cut costs, they can cause trouble for the economy. The hope is that since S&P 500 profit margins are still historically high, the cost-cutting impulse will be subdued.
But figures from the Commerce Department’s Bureau of Economic Analysis offer a very different view of what has happened with overall U.S. corporate profits over the past several years. Growth has been lower and margin pressures worse than the S&P 500 figures.
According to the BEA measure, after-tax profits in the second quarter were only 6% higher than they were three years earlier, which compares with a gain of 50% in S&P 500 net income over the same period. After-tax profits as a share of gross domestic product—a rough approximation of overall U.S. profit margins—slipped to 8.7% from 9.4% over that period, despite the profit boost from the 2017 tax cut.
There are important differences between the BEA profits measure and S&P 500 earnings numbers. First, the BEA is measuring profits at all U.S. companies, down to the local dry cleaner, while the S&P 500 figures are only for the large, public companies that make up the index. Many S&P 500 companies are multinationals with substantial overseas earnings that aren’t fully captured in the BEA’s figures. Additionally, the S&P figures are based on companies’ financial reports. The BEA, while using financial reports for its initial estimates, ultimately relies on tax data.
Still, there is substantial overlap between the two measures, and they usually track each other. When they don’t, as in the late 1990s, when S&P 500 profits surged but BEA showed profits stagnating, it can be a sign that something is amiss. Ultimately, investors found that their confidence in big companies’ earnings power in the late 1990s was misplaced. Stocks fell sharply.
The most important difference between how profits are reflected in companies’ financial reports and how they are counted by the BEA might be in the treatment of capital gains, says economic consultant Joseph Carson. Indeed, the BEA itself has stated that the reason its measure didn’t show that late 1990s run-up in profits “was primarily attributable to capital gains.”
Under accounting rules, capital gains and losses can make their way into earnings in a variety of ways, notes David Zion, head of accounting and tax research firm Zion Research Group. If a company’s equity investments rise in value, for example, that unrealized gain can flow into the income statement. As a result of new accounting rules adopted last year, capital gains are now even more apt to show up in earnings.
The BEA, on the other hand, aims to measure profits companies generate through their business operations, and so excludes capital gains and losses.
The implication is that a fair amount of the earnings growth the S&P 500 has exhibited in recent years might be ephemeral, related to gains in the value of companies’ investments rather than the underlying strength of their operations. Under the hood, then, profit margins aren’t as good as they appear. If business starts to falter, companies’ may take an ax to costs, with bad repercussions for the economy.
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