Better-Than-Expected Results, but the Profit Outlook Is Dim
Estimates are coming down as management teams grapple with expectations for slowing growth.
U.S. profits contracted for the second consecutive quarter while earnings growth slowed but stayed positive in Europe and Japan.
Travel-related businesses in the U.S. and Europe delivered strong results, while basic materials and other economically sensitive companies fared worse.
Analysts’ profit expectations for the full year remain positive, but economic and geopolitical risks make the outlook uncertain.
Companies beat lowered profit forecasts at a better-than-expected clip during the first quarter of 2023. The results came despite stubbornly high inflation, rising interest rates and slowing business conditions.
In the U.S., the profits of S&P 500 constituents sank -2.2% compared to the first quarter of 2022. Still, expectations are everything, and companies beat sales and earnings estimates at a pace above the five-year average, according to FactSet.
Though profit growth was negative, the results represent an improvement over the -4.7% earnings contraction during the final quarter of last year.
Strong first-quarter performances from broadline retailers and travel and leisure companies helped put consumer discretionary at the top of the earnings scorecard. Amazon was a key driver. After writing down $7.6 billion in paper losses on its stake in electric vehicle maker Rivian in the first quarter of 2022, the online retail giant had easier comparisons to beat this year. Earnings were much weaker in other corners of the consumer discretionary sector, including declines in leisure products, household durables and textiles, apparel and luxury goods.
Elsewhere, airlines were the key contributors to earnings growth in the industrials sector. At the other end of the spectrum, the economically sensitive materials sector yielded the weakest results, with profits falling more than -25%.
Non-U.S. Profits Were Positive
In Europe, profit growth slowed but remained firmly in positive territory at 9.5%. The continent’s more robust profit growth compared to the U.S. continues post-pandemic earnings trends.
According to Goldman Sachs research, inflation and rising commodity prices have fueled revenue growth and expanded profit margins. A larger weighting of commodity-related businesses has also boosted the Stoxx 600’s profit readings.1
During the first quarter, the financials sector delivered the strongest earnings growth and the widest earnings beats among European companies. Banks were at the forefront as some Europe-based institutions benefited from the deposit migration in the U.S.
“We have seen 5% growth of our deposit base in commercial banking in the U.S. So, we were one of the beneficiary banks of the deposit migration from medium-sized banks into large banks, and we obviously continue to cherish our propositions in deposits to continue attracting deposits at the right price.”
Georges Elhedery, CFO & Executive Director, HSBC Holdings
In Japan, communications services and automakers helped drive robust 35.5% profit growth. Sales also grew 9.4%. Automobile companies were the top contributors to sales growth as semiconductors became more available and production constraints eased.
“The global semiconductor supply shortage is yet to be resolved. The situation is improving. China’s end to zero-COVID policy resulted in normalizing its economic activity.”
Makoto Uchida, CEO, Nissan Motor Co., Ltd.
Five Earnings Season Themes We’re Watching
1. Nvidia Leading the Charge on High Expectations for Artificial Intelligence
The stock of chipmaker Nvidia surged 25% in one trading day after massively increasing its future business guidance. The company, whose capitalization subsequently crossed the $1 trillion mark, raised sales guidance for the coming quarter from $7.2 billion to $11 billion. That’s more than 50% above Wall Street analyst expectations. Data center applications are driving the growth, reflecting the demand for computing power required for artificial intelligence (AI) applications.
The results are even more surprising since other chip makers had reported poor results. Furthermore, some of the biggest spenders on AI chips, including Amazon, Alphabet and Meta, had discussed cutting back on spending. With this in mind, many analysts expected Nvidia to guide down, not up.
The questions for investors: Are we seeing the first wave of a rising tide that spreads and ultimately lifts all boats in the AI and chips ecosystem? Or is this purely about Nvidia gaining market share and muscling out the competition?
2. Stabilizing Profit Margins
As we saw at the close of 2022, companies remain focused on aligning cost structure by streamlining their product offerings and reducing headcount amid signs of slowing demand and an uncertain economic outlook. We find it especially notable that demand is normalizing in areas of technology, e-commerce and home goods where the pandemic temporarily, but significantly, accelerated demand.
Easing input costs coupled with stickier pricing power is reflected in stabilizing profit margins, which reversed a recent string of quarterly declines. As shown below in Figure 1, margins improved to 11.5% from 11.3% last quarter but remained below last year’s 12.2% mark.
Figure 1 | Profit Margins Stabilized After an Extended Decline
Source: FactSet. Data as of 2/17/2023.
3. Bank Profits Were Surprisingly Strong
Given the steady stream of negative news about bank failures, many investors might be surprised by the strength of the revenue and earnings growth in the banking industry. S&P 500 banks saw 28% earnings growth on revenue growth of 18%. Results were even more robust in Europe, where banks reported 68% earnings growth on revenue growth of 13%.
Improving net interest margins was one key earnings driver for U.S. banks. The interest rates they earn on loans have risen much faster than the rates they pay savings account owners.
This positive dynamic for banks could change as depositors find more attractive interest rates in short-term savings options like money market funds and U.S. Treasury bills. Account outflows have been a factor in some bank failures as large depositors withdrew savings from certain regional banks in search of higher yields.
Many banks will likely need to increase the rate they pay depositors to retain customers, which could lead to softer financial results in future quarters.
4. Different Spending Habits for Higher- and Lower-Income Consumers
The differentiated spending patterns between higher- and lower-income consumers have continued into 2023. Signs of stress are showing up in lower-income consumers.
Pandemic stimulus checks have long been spent, inflation has eaten away at purchasing power, and weaker equity market returns coupled with a slowing housing market have lessened the “wealth effect.” The impact is higher at lower-income levels where higher food and shelter costs make up a larger portion of income.
Visa’s quarterly earnings call indicated that consumers hadn’t closed their wallets. The company highlighted a spending slowdown in March and April. Factors included lower tax refunds, retail discounting, lower gas prices and declining transaction sizes as inflation moderates. The credit card company also noted leisure spending, evident in earnings reports for travel and entertainment companies.
We also saw signs of higher-income consumers “trading down” to more cost-effective options. Walmart specifically called this out on its earnings conference call.
“So that’s the big takeaway here, and I think it’s an important point as you think about the future of Walmart as we have these new shoppers coming to us, as we have higher income shoppers coming to shop for not only grocery but general merchandise, we want to retain those. We want to retain them with better experiences, better product offerings, and we’re seeing that in the actions that we’re taking today.”
John Rainey, CFO, Walmart
5. Less Focus on Inflation
U.S. consumer prices increased by less than 5% in April for the first time since April 2021. Figure 2 shows a corresponding decline in company mentions of inflation during earnings conference calls compared to prior quarters.
Figure 2 | Inflation Declining as a Talking Point on Earnings Calls
Number of S&P 500 Companies Citing "Inflation" on Earnings Calls
Data from 6/30/2018 – 5/15/2023. Source: FactSet.
Inflation remains a concern, especially in the materials, consumer staples, energy and financials sectors, where more than 70% of companies mentioned inflation during earnings calls. However, just like the actual Consumer Price Index (CPI) numbers, these concerns appear to be moderating.
“While the pace of inflation has slowed, elevated levels continue to pressure both input costs and demand, particularly in industrials, durable goods and housing. On the bright side, demand in agriculture and energy markets remains resilient, as does consumer demand for personal care and household items.”
Howard Ungerleider, President & CFO, Dow
Looking Ahead: Management Teams Are Setting Expectations Lower
The percentage of companies issuing negative forward guidance declined despite the unclear economic outlook. Not every company provides a forward-looking perspective on next quarter’s earnings. However, 59% of S&P 500 companies that have issued guidance provided lower-than-expected forecasts compared to 76% of companies last quarter and the five-year average of 59%.
Analysts forecast S&P 500 earnings to decline again next quarter. However, they anticipate a rebound later in the year due to expectations that input costs will normalize and comparisons against the prior year will become easier. The current estimates are for a decline of -6.4% in the second quarter, followed by a slight increase of 0.7% in the third quarter.
In Europe, earnings estimates for next quarter are trending lower but remain positive. Expectations are highest among financials, cyclicals and utilities. On the other hand, earnings estimate revisions are heading lower in energy, materials and health care.
Estimates for the calendar year 2023 have trended slightly higher recently as companies reported stronger results than expected. Analysts expect full-year results to be positive in the U.S. and Europe. However, much uncertainty remains due to rising recession risks, stubbornly high inflation, softening demand and elevated geopolitical tension.
Source: Refinitiv. Based on the Stoxx 600 Index as of 5/23/2023.
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