Celevator supervisor The world’s largest companies left Davos on January 20 after a week of high tide. The mood at the annual carnival is not somber, if not rosy. Behind closed doors, CEOHe acknowledged that while the war in Ukraine remained a humanitarian tragedy, risks to the world economy could be contained for now. Central banks have taken inflation seriously. If there is a recession in the US and Europe, it should be manageable. The Chinese delegation has sent the clearest signal in years that China will not only reopen after a draconian “zero-coronavirus” regime, but also reintegrate into the world. Globalization may not be the healthiest, but news of its demise seems exaggerated by snow-covered bosses.
Back on Earth, things look even more dangerous. “Earnings season is going to be a confessional,” said Jim Tierney of investment firm AllianceBernstein, referring to the month or so when most companies report their quarterly results. Profits at the U.S. banking giant, which kicked off the past week or so, are down 20% year-over-year. Investment bankers were hit especially hard as deals collapsed amid economic uncertainty. In early January, Goldman Sachs laid off about 3,200 employees.
Profit forecasts for big U.S. companies have been sharper than the plunge in black pistes.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 now points to a year-over-year decline in profits, the first decline since the height of the pandemic in 2020 (see Figure 1).
For many companies, costs are rising faster than sales. Businesses are finding it harder to resist rising wages than convincing customers to absorb rising costs. That will compress margins at a pace that analysts have yet to fully price in, who still collectively forecast profits to grow in 2023. If the U.S. economy does slip into a recession, as many economists expect, profits will almost certainly fall further. Since World War II, earnings per share have fallen by an average of 13% during economic contractions, according to Goldman Sachs calculations.
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 global price of Tesla vehicles has been reduced by 20%.
If demand falters, companies admit costs are too high—a second confession. Tech companies are doing so with particular enthusiasm as demand for their products slowed from earlier pandemic-induced highs last year. Apple boss Tim Cook will take a 40% pay cut this year. Twitter is auctioning off its neon bird wall art. Less symbolically, on Jan. 18, Microsoft announced plans to cut 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 tech pandemic’s hiring spree, but one Silicon Valley venture capitalist believes it will provide “cover in the air” for more tech companies to slash their wages and shore up their cash flow.
The third confession of the company 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 tame inflation. Now that money is expensive, such 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 decoupling of China from 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 ships nearly 40% cheaper 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. A few have jumped. United Airlines raised prices without putting off vacationers and business travelers. 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 has lost about half its value since peaking in the fall of 2021, issued an upbeat 2023 profit forecast. On Jan. 19, Reed Hastings stepped down as co-founder of Netflix.CEOpossibly because he believes the worst is over for the company he founded 25 years ago.
This year, however, such confidence will be the exception rather than the norm. Overall, the positive earnings surprises of recent quarters have become less positive (see Figure 2).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. True corporate life takes place in places less rare than the Swiss Alps. ■