Signs of recession pain expected in earnings reports

With costs still rising, interest rates starting to tighten and consumer spending falling, the results are expected to reveal the start of a US income recession, which will last until the second half of 2023, according to Bloomberg Intelligence strategists.

While analysts have been busy reducing forecasts in recent weeks, the consensus for corporate profits in 2023 remains “extremely high” with or without an economic recession, according to Morgan Stanley’s Michael Wilson, who warned that shares could fall as much as 25% in the first quarter under pressure from poor earnings and guidance.

Madison Faller, global strategist at JPMorgan Private Bank, expects management to make cautious comments as recession risks rise, higher than normal inventories and wage pressures.

“With the advanced economic slowdown, we think the Street estimates will likely continue to move lower, but not collapse immediately,” Faller said. “Margin degradation will continue through 2023 and will be the focus of management’s discussions with investors.”

With Wall Street banks including JPMorgan Chase & Co., Citigroup Inc. and Bank of America Corp. just getting started, there are five key areas that market participants will be watching this earnings season:

Food shaft

While the signal of earnings is important, the attention of investors is laser-focused on the next move of the Federal Reserve. And with US and European interest rates expected to rise in the summer, any comments on the impact of monetary policy will be closely scrutinised. Investors will also want to know whether the company has been able to secure low borrowing costs for years to come and avoid the pinch of rising interest rates.

Against this backdrop, earnings estimates have fallen over the past year. But it’s still too high, according to strategists like Goldman Sachs Group Inc. David Kostin, who expects more cuts because the risks of recession, margin pressure and new corporate taxes outweigh the risks of increases such as China’s reopening.

“The data increasingly points to a slowdown in activity across the board,” said James Athey, investment director at Abrdn. “Many sectors now seem immune to the slowdown. Realistically, I’m still in the early stages of the impact of Fed tightening.

Consumer spending

Slowing demand will be the focus of this reporting season as a harbinger of recession. US economic data showed consumers lost momentum in November amid higher interest rates and higher inflation. Americans are scrambling to save and lean more on credit cards, raising questions about whether they will be able to continue to drive economic growth through 2023.

Some companies have managed to navigate these headwinds, for now at least. Nike Inc.’s quarterly sales beat Wall Street estimates amid higher demand during the holidays and FedEx Corp. earnings. beat analysts’ estimates due to price increases and cost cuts. In Europe, Ryanair Holdings Plc, the region’s biggest discount airline, raised its full-year profit target after a stronger-than-expected Christmas travel period, while holiday sales rose at Tesco Plc and many other British retailers.

The effort was nowhere near successful. Tesla Inc. delivered fewer vehicles than expected last quarter despite offering generous incentives in its biggest market, sending the stock tumbling. Macy’s Inc. is also expected to report weaker fourth-quarter sales than previously forecast, and sees continued pressure on consumers in 2023.

Job cuts

The earnings report will also be watched for further evidence of layoffs as companies react to a worsening backdrop. The phenomenon is most common in technology, where companies cut jobs quickly at the beginning of the pandemic, as evidenced by the recent announcement of Amazon.com Inc. and Salesforce Inc. Meanwhile, the owner of Facebook Meta Platforms Inc., Apple Inc. ., and Alphabet Inc. all slowed or paused rent, while Taiwan Semiconductor Manufacturing Co.

In the banking space, Goldman Sachs, Morgan Stanley, Credit Suisse Group AG and Barclays Plc have all laid off staff or announced they will in the coming months. McDonald’s Corp. cut company jobs, the first restaurant chain in the US to do so despite relatively strong sales performance in recent years.

“Many companies have become too big for a shrinking economy and a tougher regulatory environment, and they really need the right size,” said Marija Veitmane, senior strategist at State Street Global Markets, who emphasized “It is important to look at the earnings guidance, which may be more negative than is currently reflected in the consensus estimate.”

Energy prices

The impact of falling electricity prices will be closely watched after WTI oil fell more than 35% from its March peak and gas slid in Europe amid milder weather – a big change for the commodity from six months ago. Exxon Mobil Corp., the largest U.S. oil company, has said lower crude oil and natural gas prices negatively impacted fourth-quarter earnings.

U.S. energy company profits are set for the fourth straight quarter of at least double-digit growth, but could see annual earnings decline from the second quarter of 2023 to at least the first quarter of 2025, according to Bloomberg Intelligence.

“Slowing global demand for energy commodities will weigh on the energy sector,” said Joachim Klement, head of strategy, accounting and sustainability at Liberum Capital.

On the flip side, Klement noted that lower electricity prices are “good news for the sector experiencing margin pressure in 2021 and 2022. This is especially pronounced in the consumer discretionary world.”

China reopens

Comments from companies with revenue and cost exposure to China will be closely scrutinized after the world’s second-largest economy reopens on January 8. Japan and tourism stocks in Southeast Asia should also be boosted.

However, with China’s Covid cases on the rise and many countries imposing border restrictions on people traveling from those countries, the impact of reopening on global earnings could be limited in the current quarter.

Elsewhere in the company’s earnings:

Asian:

• Taiwan Semiconductor Manufacturing rose in Taipei, tracking higher ADRs, after the chipmaker said it was cutting spending in anticipation of weaker sales. While analysts note the prospects for companies to consider in the sector, they also see signs of potential short-term downside.
• Shares in Fast Retailing fell after Uniqlo owner Uniqlo’s operating profit missed analysts’ estimates of the impact of the pandemic in China

EMEA:

• Kindred fell after preliminary 4Q results missed expectations. Online gambling companies say betting activity during the soccer World Cup is not enough to make up for lost revenue from fewer soccer league games.
• Shares of Partners Group declined after the Swiss company reported assets under management that it did not want. The “significant slowdown” is “clearly a negative surprise,” Vontobel analysts said. Separately, Societe Generale and Citigroup downgraded the stock

American:

• Bank stocks reversed earlier losses to trade higher on Friday, even as executives including JPMorgan’s Jamie Dimon and Bank of America’s Brian Moynihan warned of an uncertain economic environment as four of the six largest US lenders reported fourth-quarter results.
• Wendy’s shares edged higher as investors focused on better-than-expected fourth-quarter results, an increase in capital allocation, and the removal of Trian’s strategic review distraction.

—With assistance from Ishika Mookerjee

Learn how to navigate and strengthen trust in your business with The Trust Factor, a weekly newsletter that examines what leaders need to succeed. Log in here.