Cadministration staff The world’s largest companies seem to be in high spirits lately. While they view the war in Ukraine as a humanitarian tragedy, the risks to the world economy now appear to be under control. Central banks have taken inflation seriously. The world economy is performing better than expected a few months ago. China’s communist government has launched a charm offensive to signal that the country is not only about reopening after a draconian “zero-COVID-19” regime, but reintegrating into the world. Globalization may not be the healthiest, but news of its demise seems overblown to many bosses.
The mood in the corner office may be about to turn sour. “Earnings season is going to be a confessional,” said Jim Tierney of investment firm Bernstein, referring to the month or so when most companies report their quarterly results. Profits at the U.S. banking giant, which kicked off earlier this month, fell 20% year-on-year. Investment bankers have been hit especially hard as deals fall through due to economic uncertainty. Goldman Sachs is laying off about 3,200 employees.
Giants in other industries by January 25, from manufacturing (3rice and Boeing) to consumer goods (Kimberly-Clark) and technology (Microsoft), reported weak earnings. Profit expectations for major U.S. companies are falling sharply.In the final three months of 2022, analysts revised their earnings forecasts for the fourth quarter small&P The 500 fell 6.5 percent, twice the magnitude of a typical downward correction. The collective wisdom of Wall Street on the past quarter points to a year-over-year decline in profits for the first time since the height of the pandemic in 2020 (see chart).
For many companies, costs are rising faster than sales. Businesses are finding it harder to resist rising wages than to convince customers to accept higher prices. That could compress profit margins at a pace not yet fully priced in by analysts, who are collectively sticking to forecasts that profits will grow through 2023. If the U.S. economy does slip into a recession, as many economists expect, overall profits will almost certainly fall. According to Goldman Sachs, since World War II, earnings per share have fallen by an average of 13% during economic contractions.
The first thing companies have to admit is consumer boredom. On the company’s conference call with analysts late last year, many talked about weak demand as shoppers reined in spending on discretionary items. Procter & Gamble, whose products range from diapers to detergent to dental floss, reported sales declines across its businesses in the fourth quarter. It managed to meet earnings estimates only because it raised prices by 10% and plans to increase further in February.
Yet bosses clamoring for this “pricing power,” a favorite brag last year, will be quieter this earnings season. While households are still spending the excess savings they accumulated during the pandemic, they are increasingly hunting for bargains. U.S. consumers frugal on everything from restaurants to electronics in December, leading to a seasonally adjusted 1.1 percent decline in retail sales from the previous month. Constellation Brands, which produces and distributes Corona beer for U.S. drinkers, said Jan. 5 it plans to slow price increases this year. Many retailers are discounting items to clear inventory. The price of Tesla electric vehicles has been reduced by 20% globally.
As demand waned, companies began to admit that costs were too high—a confession they made a second time. Tech companies are doing so with particular enthusiasm, as demand for their products slowed last year from pandemic-induced highs. Apple boss Tim Cook will take a 40% pay cut this year. Twitter is auctioning off its neon bird wall art. On a less symbolic note, on Jan. 18, Microsoft announced it was cutting 10,000 jobs. Two days later, Alphabet, Google’s parent company, said it would cut 12,000 jobs. The layoffs haven’t quite reversed the pandemic’s hiring spree at Big Tech, but a prominent Silicon Valley venture capitalist believes it will provide “cover in the air” for more tech companies to slash their salaries and shore up their cash flow .
The company’s third confession concerns the fate of the profits to be earned. This earnings season is also a time for companies to map out their spending plans for the coming year. Overall, large U.S. corporations tend to split spending evenly between shareholder spending (via dividends and share buybacks) and investment (R&D, capex, and M&A).
In the era of cheap money, spending was often debt-financed before central banks started raising interest rates to curb inflation. Now that money is getting more expensive, this kind of borrowing may be reduced. As for dealmaking, many acquirers are still sorting out the mess created by deals struck at the highest prices during the pandemic merger boom. Acknowledging that some of these writedowns have fallen in value is more likely than announcing a desire to replenish war funds and strike more deals.
That leaves investment. The megatrends of the 21st century—decarbonization, digitization, and the decoupling of China and the West—support huge spending on climate-friendly technologies, robotics and software, and non-Chinese factories. Capital spending should therefore be better protected than usual against the coming recession, argues one European industrial boss.
perhaps. For now, though, most companies remain cautious. After capital spending by U.S. companies edged up in the third quarter of 2022, a tracker of business spending plans compiled by Goldman Sachs pointed to continued growth, but at a much slower pace.
Many companies are likely to postpone major spending decisions until economic uncertainty lifts. Swedish telecom equipment maker Ericsson has warned that its U.S. customers are increasingly delaying investments in new networks. Dell shipments down nearly 40% personal computers, which sells primarily to enterprise customers, in the fourth quarter, compared with the same period last year, according to data center, a research firm. Logitech, which makes keyboards, webcams and other desktop-related hardware, now expects revenue to fall 15% for the fiscal year ending in March, down from a previous estimate of no more than 8%. Software makers such as Microsoft and chipmakers such as Intel could also be affected by shrinking digital budgets.
Like all earnings seasons, this one will bring positive surprises. Some have already sprung up. United Airlines raised prices without delaying passengers. Netflix beat expectations by adding 7.7 million new subscribers in the fourth quarter, thanks in part to a new, cheaper ad-breaking service. The struggling streaming service, which issued an upbeat 2023 profit forecast, has lost about half its market value since peaking in the fall of 2021. On January 25, Tesla reported a record quarterly profit.
This year, however, such confidence will be the exception rather than the norm. Overall, the positive earnings surprises of recent quarters have become less rosy.reached an all-time high percentage gross domestic product Last year, after-tax corporate profits seemed overdue for a correction. They may still fall further. The high debt and low taxes that have fueled corporate earnings for decades are no longer the tailwinds they used to be as interest rates rise and appetite for deficit-funded tax cuts wane. As this new reality deepens, CEOHis half-full glasses may suddenly look half-empty. ■
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