The first-quarter earnings season will be challenging with the economy laboring under still elevated inflation and the recent banking crisis. Earnings are slated to decline by -6.6% year-over-year, but if analysts are to be believed, this quarter should mark the nadir of the pace of earnings contraction. The items weighing on earnings include slowing economic growth, rising costs, and a strong dollar. The ability of companies to pass on higher prices to protect profit margins will remain a critical variable. With the rising risks of a recession in 2023 and the possible contraction in credit emanating from the banking crisis, forward guidance will be crucial.
Eleven S&P 500 companies are scheduled to report earnings in the coming week, but the primary focus will be on the financials and the banks in particular. There are a handful of other companies like Delta Air Lines
DAL
(DAL), BlackRock
BLK
(BLK), and UnitedHealth (UNH) on the calendar. Among the banks reporting are JPMorgan Chase
JPM
(JPM), Citigroup
C
(C), First Republic Bank
FRC
(FRC), PNC Financial (PNC), and Wells Fargo
WFC
(WFC According to FactSet, the consensus year-over-year earnings estimates for financials are showing an increase of 3.2%. The strength of the core deposit and lending businesses and the status of credit losses will be of interest. While the current financial results are essential, the banking crisis began late in the quarter, which will shift the focus to future expectations. Indeed, investors will be laser-focused on the forward guidance and the cost of deposits leaving the banking system. For more about the stress in the U.S. banking system, including the contraction in lending, a recent update is here.
The energy sector continues to benefit from energy prices, but earnings growth is expected to moderate to almost 10% year-over-year while sales shrink by -5%. Some investors remain positive on the sector as regulatory filings showed that Berkshire Hathaway
BRK.B
bought more Occidental Petroleum
OXY
(OXY) shares this year and owned more than 20% of the company. A previous piece discussed why Warren Buffett’s Berkshire Hathaway probably favors Occidental Petroleum.
While the sales growth may seem elevated for the quarter, the high inflation rate boosts the result. Sales growth is closely tied to nominal GDP growth, combining after-inflation economic growth (real GDP) with inflation. With nominal GDP growth expected to remain in the high single digits year-over-year for the first quarter, the consensus estimate of 1.9% year-over-year sales growth for the S&P 500 looks achievable.
Unfortunately, most of the expected nominal GDP growth is inflation rather than actual growth. Inflation has been trending lower since mid-2022 but remains well above typical and targeted levels.
A simple model looking at the differential in price growth for producer’s inputs (PPI) versus the price increases hitting consumers indicates continued pressure on profit margins. While the model shows that the situation should improve, feeding through the system will take some time. Hence, the low-single-digit sales growth for the S&P 500 is expected to result in a mid-single-digit decline in earnings growth year-over-year.
The year-over-year prices of oil and natural gas were lower, which resulted in the expected decline in year-over-year revenues for the industry. Despite the decrease in sales, energy companies are still expected to grow earnings this quarter. While the reduction in energy costs hurts the revenues of the energy sector, the over 19% year-over-year decrease in the average oil price for the quarter positively impacts the costs for many non-energy companies. Labor costs will be a headwind for companies, with average hourly earnings rising at a 4.2% year-over-year rate in March.
Overseas shipping costs are back to normal levels, which is a positive. Transportation and freight prices remain relatively high, driven by fuel and wage costs, and will continue to pressure margins.
The U.S. dollar is well off its high against other currencies, but it will still negatively impact earnings for companies doing business overseas. With approximately 40% of the sales of S&P 500 companies coming from international sources, this negative drag for dollar strength is likely to be a consistent, though less severe than in recent quarters, issue for companies selling products internationally. International exposure could be a boon to some companies’ earnings, with China reopening sparking economic growth in that region.
Earnings for the first quarter are forecasted to decline by -6.6% year-over-year. On a positive note, the reopening of China’s economy and resultant economic growth could boost some earnings and expectations. Analysts expect this quarter to be the worst year-over-year earnings decline, with positive earnings growth resuming in the second half of the year. The recent banking crisis likely makes the positive expected earnings growth of the financials almost immaterial, as the focus will rightly turn to the health of the system and future expected earnings. There are signs that the improving inflation problem could bolster profit margins in coming quarters. Still, the rising specter of recession due to possible credit contraction increases the uncertainty in that forecast. Given the unsettled economic environment and consensus estimates pricing in positive earnings growth in the back half of the year, forward guidance from companies will be essential.
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