First Signs of Recession Pain Look Set to Emerge from Earnings

(Bloomberg) — Just as investors are celebrating the prospect of peak inflation and potential for a soft landing, this earnings season is prone to show there’s still plenty that ought to keep them up at night.

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With costs still on the rise, rates of interest beginning to bite and consumer spending declining, results are expected to disclose the beginning of a US earnings recession, which can last until the second half of 2023, in response to Bloomberg Intelligence strategists.

While analysts have been busy slashing their forecasts over the past few weeks, the consensus for corporate profits in 2023 stays “materially too high” with or without an economic recession, in response to Morgan Stanley’s Michael Wilson, who warns that stocks can fall about 25% in the primary quarter under pressure from poor earnings and guidance.

Madison Faller, global strategist at JPMorgan Private Bank, expects management to offer cautious commentaries given rising recession risks, higher than normal inventories and wage pressures.

“With developed economies slowing, we expect Street estimates will likely proceed to maneuver lower, but not collapse immediately,” Faller said. “Margin degradation will likely proceed into 2023 and might be the main target in management discussions with investors.”

With Wall Street banks including JPMorgan Chase & Co., Citigroup Inc. and Bank of America Corp. having just kicked things off, listed here are five key areas that market participants might be watching this earnings season:

Fed Pivot

While signals from earnings are vital, investors’ attention is laser-focused on the Federal Reserve’s next moves. And with US and European rates of interest expected to peak by the summer, any comments on the impact of monetary policy are prone to be closely scrutinized. Investors may even be keen to learn whether firms have been in a position to secure low borrowing costs for the approaching years and avoid feeling the pinch from rising rates of interest.

Against that backdrop, earnings estimates have fallen for many of last yr. Yet they’re still too high, in response to strategists like Goldman Sachs Group Inc.’s David Kostin, who expects further cuts as the danger of a recession, margin pressure and latest corporate taxes outweigh upside risks comparable to China’s reopening.

“The information is increasingly pointing toward slowing activity across the board,” said James Athey, investment director at Abrdn. “Only a few sectors now seem proof against the slowing. Realistically, I believe we’re still within the early stages of the impact of Fed tightening.”

Consumer Spending

Slowing demand might be in focus this reporting season as a harbinger of recession. US economic data showed consumers lost momentum in November amid higher rates of interest and elevated inflation. Americans are tapping into savings and leaning more on bank cards, raising the query of whether or not they’ll have the option to proceed driving economic growth through 2023.

Some firms have managed to navigate these headwinds, for now a minimum of. Nike Inc.’s quarterly sales exceeded Wall Street estimates amid higher demand in the course of the holidays and FedEx Corp. earnings beat analysts’ estimates attributable to price increases and value cuts. In Europe, Ryanair Holdings Plc, the region’s biggest discount airline, raised its full-year profit goal following a stronger-than-expected Christmas travel period, while holiday sales rose at Tesco Plc and plenty of other UK retailers.

The attempts haven’t been successful in all places. Tesla Inc. delivered fewer vehicles than expected last quarter despite offering hefty incentives in its biggest markets, sending its shares tumbling. Macy’s Inc. also expects to report fourth-quarter sales that were weaker than previously forecast, and sees continued pressure on the patron in 2023.

Job Cuts

Earnings reports may even be watched for further evidence of layoffs as firms react to the deteriorating backdrop. The phenomenon is most pronounced in tech, where firms are slashing jobs at a pace nearing the early days of the pandemic, as evidenced by recent announcements from Amazon.com Inc. and Salesforce Inc. Meanwhile, Facebook owner Meta Platforms Inc., Apple Inc., and Alphabet Inc. are all slowing or pausing hiring, while Taiwan Semiconductor Manufacturing Co. is bracing for weaker-than-expected sales by reducing spending.

Throughout the banking space, Goldman Sachs, Morgan Stanley, Credit Suisse Group AG and Barclays Plc have all either already fired staff or announced that they plan to accomplish that in coming months. McDonald’s Corp. is cutting corporate jobs, the primary restaurant chain within the US to accomplish that despite its relatively strong sales performance lately.

“A number of firms have turn out to be too big for the shrinking economy and the tougher regulatory environment, and so they are indeed in a greater need for right-sizing,” said Marija Veitmane, a senior strategist at State Street Global Markets, who stresses the “importance of earnings guidance, which is prone to be loads more negative that currently reflected in consensus estimates.”

Energy Prices

The impact of falling power prices might be closely monitored after WTI oil tumbled over 35% from its March peaks and gas slid in Europe amid milder weather — an enormous turnaround for commodities from just six months ago. Exxon Mobil Corp., the biggest US oil company, already said lower crude and natural gas prices had a negative impact on fourth-quarter earnings.

US energy firms’ profits are set for a fourth consecutive quarter of a minimum of double-digit growth, but could post year-over-year earnings declines from the second quarter of 2023 to a minimum of the primary quarter of 2025, in response 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 power prices are “excellent news for sectors which have suffered a margin squeeze in 2021 and 2022. This is especially pronounced in the patron discretionary world.”

China Reopening

Commentary from firms with revenue and value exposure to China might be closely scrutinized, after the world’s second-largest economy fully reopened on Jan. 8. Mining, technology and luxury firms within the US and Europe derive sizable sales from China, while cosmetics makers in Japan and tourism stocks across Southeast Asia also needs to get a lift.

Nonetheless, with Chinese Covid cases surging and plenty of countries imposing border restrictions for travelers from the country, the impact of the reopening on global earnings could also be limited in the present quarter.

Elsewhere in corporate earnings:

–With assistance from Ishika Mookerjee.

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