With 90% of market cap reporting, earnings season in the US is over for all intents and purposes.
Profits fell just 3% YoY against expectations for a 7% decline, leaving investors to ponder a familiar question: Is “better-than-expected” an accurate description when the hurdle was so low?
“Q1 reporting season does little [to] alter our view that growth is slowing,” JPMorgan analysts led by Marko Kolanovic wrote. “The large EPS positive surprise… comes after bottom-up analysts had lowered the bar heavily just before the start of reporting season.”
71% of companies beat EPS estimates, and 54% beat by at least a standard deviation, according to Goldman. Those were the highest rates since Q1 and Q2 2022, respectively.
The trough is now seen in Q2, when consensus expects profits will contract 8% from the same period a year ago.
It doesn’t much matter which statistic you consult. If you set aside the “low bar” caveats, results handily exceeded expectations. Top-line growth was 4% in aggregate, double the expected 2%. Margins contracted “just” 99bps. Although Q1 marked the third consecutive quarter of YoY margin compression, consensus expected profitability would be crimped by almost 150bps. As Goldman’s David Kostin noted, “margins in every sector surprised to the upside.”
So, where to from here? Well, to state the obvious for the umpteenth time, that depends entirely on whether recession predictions pan out, but assuming they don’t, it’s possible we’ve seen the trough excluding energy, which is up against some tough comps.
Ex-energy, YoY EPS growth bottomed in Q4 and it looks like the worst of the revision cycle is over, Kostin went on to suggest, noting that “the breadth of revisions across the market has also improved.”
As the chart shows, revision sentiment was consistent with recession late last year, but it’s back to “even” now, where that means EPS revisions are split evenly between negative and positive.
Some readers are, no doubt, skeptical of any constructive outlook given the myriad macro crosscurrents, but you can’t have it both ways, and by “you” I actually mean me. I’m constantly torn between the temptation to deride glass half-full assessments as Pollyanna-ish and my natural inclination to chuckle at how long we’ve been waiting for the profit “reckoning.”
While it’s true that the “reality” of severe macro conditions often takes quite a while to manifest in EPS troughs, and while acknowledging that management teams will hold off until the very last moment before guiding for the worst, this is a unique cycle in many ways, not least of which is the persistence of corporate pricing power.
Both Goldman and consensus expect more in the way of margin compression, but company analysts see a quick inflection on the way to new record highs.
Although Kostin is actually more optimistic that bottom-up consensus for 2023, he sees margin estimates for 2024 as far too rosy (note the disparity between the two dashed lines in the chart above looking out past this year).
“We estimate S&P 500 net profit margins will expand by just 11bps to 11.4% [in 2024] due to the ongoing dynamics of slow revenue growth and elevated wage growth,” Kostin wrote late Friday. By contrast, consensus sees nearly 100bps of margin expansion next year, taking overall profitability for corporate America to new highs.
About the only thing any of us can say for sure is that today’s estimates, whether they emanate from top-down strategists, bottom-up consensus, the buy-side or somebody else, will need a lot of luck to be right. That’s always true, but particularly so in the current environment.
As Rabobank’s Michael Every put it this week, most market observers don’t see “the bigger political-economy picture of why firms are able to raise prices, which speaks to concentrated corporate power that can shrug off monetary policy.” Nor, he wrote, “are they seeing the inflationary geopolitical-economy backdrop.”
Still not sure how to think about any contraction of profit margins in the light of the greedflation discourse we’re having. Is it a matter of sectors? Of comps? I mean, margins are still historically high but any kind of contraction ought to suggest the worse of the greedflation is behind us?
it is very hard to play the expectations game for a profit. We can say companies beat the lowered expectations, but you should remember that the thinking was that the lowered expectations were still too high. The beating the lowered expectations was therefore much better than it appeared going into earnings season.
on the “greedflation” discussion: I have to admit I am a complete loss to explain it. It seems like companies are just as at a loss to explain it as anyone else. I had noticed even before the pandemic that prices for certain higher end items such as sports cars and luxury watches and handbags had gone completely haywire. People were willing to pay outrageous prices for items that are not considered collector items.
Even with the widespread inflation on all items during and after the pandemic, that people are willing to continue to pay high prices on items they didn’t need right away or had ready substitutes just does not make sense to me. Why were so many people willing to pay 30k over sticker price for a F150? there is no rational explanation for this. Why do people pay 75% more for coke, Pepsi and Doritos when there are substitutes that are just as good where the price only increased 25% and are now priced at only 50-75% of the national brands? these companies of course will raise prices as much as they think they can get away with without damaging their brands. The billions they spend on advertising and building brands does seem to have some effect. Why is Las Vegas experiencing record visitors where the hotel prices have gone up over 100% since before pandemic? I occasionally watch YouTube streams from the Las Vegas strip just to see what is going on. The one thing that strikes me is how “normal” the people look. They look like an average group of people. but somehow they are able to pay on average 250/night during the week and 450/night on weekend in addition to all the other expenses.
Even seems like insane housing prices are coming back. read an article last week about a house in a new Jersey suburb of NYC that was listed at like 450 and received 120 bids and sold for 50% above asking price. (I might be wrong about the asking price, but not about the bids or the final percentage). someday, some one may provide an expanation for all this very strange behavior by the consumer.