Bay Street in Toronto's financial district on March 18, 2020.Nathan Denette/The Canadian Press
This was supposed to be the earnings season when a much-anticipated hit to profits started to come into focus.
That hasn’t happened.
Instead, the North American corporate sector has easily trounced estimates, defying the considerable pressures of an economic slowdown, rampant inflation and soaring interest rates.
Most businesses appear unfazed by higher input costs and rising wages, freely passing them on to consumers who have the means and willingness to absorb surging prices.
That can go on for only so long.
“All economic slowdowns lead to some reduction in earnings, but this still seems a quarter or two away,” Ian de Verteuil, head of portfolio strategy at CIBC World Markets, wrote in a report this week.
Spectacular earnings are one of the more peculiar signals coming out of a strange economic moment.
The earnings season is off to a rocky start. Here’s what to look out for next
Under ordinary circumstances, periods of economic contraction reliably translate to falling profits – for S&P 500 index companies, the drop should be somewhere on the order of 20 per cent. And rising interest rates and rising prices should, in theory, weigh on consumer activity.
Many companies, however, say they see no signs that their customers are starting to cut back on spending.
Canadian Tire Corp. Ltd. CTC-A-T, for example, is seeing a growing appetite for products priced higher than $250, the company said in an earnings call on Thursday. Normally, inflation would push consumers into lower-priced categories. While the company fell short of expected profits for the quarter because of higher costs, demand does not appear to be a problem.
“Although we’re not immune to macroeconomic circumstances … we’re seeing solid customer demand,” chief executive Greg Hicks said. That’s a theme that has been echoed in earnings calls across the corporate sector over the past few weeks.
With U.S. earnings season nearing a close, nearly 80 per cent of S&P 500 companies have exceeded second-quarter profit forecasts, according to Refinitiv data. Total profit growth for the group is expected to come in at 9.2 per cent over the same quarter last year. On the Canadian side, towering energy sector profits have pushed the quarter’s earnings growth estimate up to 20 per cent for the S&P/TSX Composite Index.
“The current bout of earnings results by companies in North America has been nothing short of stunning,” Mr. de Verteuil wrote.
Management guidance for future profits has also been bullish, with the average change to company earnings forecasts for 2022 actually rising by 1.6 per cent over the course of earnings season. Wall Street now expects S&P 500 earnings to continue to rise over the next six quarters.
Is it possible for the corporate sector to avoid its reckoning this time around? Unlikely, considering that central bankers are committed to stifling excess demand in the fight against inflation.
The average North American household emerged from the worst of the pandemic in improved financial shape. Generous government benefits, combined with a sizzling jobs market and rising wages, have resulted in colossal excess savings and a broad impulse to spend.
That effectively gave corporations a licence to raise prices at will, in order to protect their bottom lines. But savings are being eroded quickly by inflation, and ultimately consumers will be forced to tighten up their finances.
“Record margins are still penciled in for 2023, which we believe is overly optimistic,” Bank of America analysts said in a note, adding that demand, “the main driver of pricing power post-COVID,” is already starting to weaken.
For the time being, there is no reason the stock market can’t continue to gain strength on the back of the consumer.
And earnings can continue to surprise to the upside, said Sébastien Mc Mahon, chief strategist at iA Investment Management.
“But I think that just pushes the problem a bit further out,” Mr. Mc Mahon said. “We’ll see those tough announcements from businesses over the coming quarters.”
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