Earnings Growth Trends Diverge in the U.S. and Europe
Corporate profit growth turns positive in the U.S. while Europe remains in the red.
Consumers buoyed U.S. corporate profits again while weak demand weighed on Europe.
High interest rates are helping to temper inflation but they’re stressing consumers and hampering the housing sector.
2024 profit estimates may be too optimistic given global growth headwinds, tight monetary policy, softer fiscal support and an aging business cycle.
Seemingly indefatigable consumers helped the U.S. break out of a three-quarter profit slump. U.S. corporate earnings growth turned positive for the first time since the third quarter of 2022, with companies reporting a 4.3% improvement. European companies struggled as year-over-year profits contracted by more than 11%.1
Amazon was the strongest performer among U.S. retailers, blowing past analysts’ profit-growth expectations. Hotels, restaurants and leisure-oriented businesses also helped propel the consumer discretionary sector. Not all consumer-facing businesses were positive, as we saw weaker results from automakers, specialty retailers and companies that make durable household products such as appliances and consumer electronics.
The communications services sector was another area of strength. See Figure 1. Facebook parent Meta Platforms was key, reporting better-than-expected results thanks to the company’s fastest rise in revenue growth since 2021.2
Energy, materials and health care companies were the weakest links. Energy companies, in particular, were facing tough comparisons to their 2022 financials, which were inflated by high commodity prices in the wake of Russia’s invasion of Ukraine.
Figure 1 | Consumer Discretionary and Communications Services Helped the U.S. Snap an Earnings Losing Streak
Data as of 11/11/2023. Source: FactSet.
Weaker Earnings Results in Europe
Weak demand was the theme in Europe as revenue growth contracted 7.7%. The number of companies beating sales expectations was also at a record low. The tone of company management calls with analysts reflected the challenging conditions. The phrase “weak demand” was used in more than 30% of calls, a level comparable to the peak of the Global Financial Crisis.3
Only four sectors reported earnings growth, with financials and consumer cyclicals the strongest. In line with the U.S., basic materials and energy companies were the weakest.
Europe’s disappointing profits are partially linked to weakness in China. Companies with China operations or tied to the country’s consumers say doing business there is becoming more challenging. The world’s second-largest economy is experiencing pressure from the manufacturing and services sectors. Consumer sentiment is weak due to the ongoing real estate crisis and high youth unemployment. The manufacturing sector suffers from weak exports, geopolitical tensions and a lack of stimulus.
4 Earnings Season Themes We’re Watching
1. Is the consumer finally slowing down?
We’ve noted the bifurcation in consumer spending patterns due to inflation for several quarters. Higher prices hit lower-income consumers first and hardest because food and shelter costs make up a significant portion of their budgets, leaving less for discretionary spending.
More recently, however, we’ve seen signs of stress in higher-income consumers. Lingering inflation has eaten away their purchasing power, and higher interest rates arising from the inflation fight have made big-ticket items like automobiles and homes less affordable.
As a result, companies catering to higher-income clientele are concerned their customers may be running out of steam. One example is Tesla. The electric vehicle manufacturer’s stock fell after the company missed analysts' expectations and CEO Elon Musk fretted about the impact of higher interest rates on affordability.
“I am worried about the high-interest rate environment that we’re in. I just can’t emphasize it enough that for the vast majority of people, buying a car is about the monthly payment. And as interest rates rise, the proportion of that monthly payment that is interest increases naturally. So, if interest rates remain high or if they go even higher, it’s that much harder for people to buy the car. They simply cannot afford it.”
Elon Musk, CEO, Tesla
2. High Mortgage Interest Rates Create a Logjam in the Housing Market
Homeowners with low-interest mortgages face a conundrum. They could sell into a strong market with the potential of getting a premium price. However, if they’re “trading up,” the cost of their next house will likely be inflated, and the mortgage will come with a higher price tag. Many are reluctant to make the trade.
With existing homeowners unwilling to sell, prospective buyers face limited options. Prices are high due to the tight supply, and if they find a house that meets their needs, high mortgage interest rates may make monthly payments unaffordable. This is reflected in Figure 2, where we see that home prices as a percent of family income are at a record high.
New home sales represent a bright spot in the housing market. Homebuilders continue to report solid earnings growth as they benefit from robust demand due to the lack of inventory for existing homes. Receding inflationary pressure on lumber and other materials is also favorable for earnings growth.
Figure 2 | Housing Affordability at Record Low Amid High Mortgage Rates and Home Prices
Data from 11/29/2013 – 9/30/2023. Source: FactSet, National Association of Realtors, U.S. Census Bureau.
3. Weight-Loss Drug Hype Machine Shifts to Overdrive
The buzz continues around Eli Lilly, Novo Nordisk and other makers of GLP-1 obesity and diabetes treatments. Demand for the breakthrough drugs has been high, and clinical trials show significant reductions in cardiac events such as stroke and heart failure.
Meanwhile, the market quickly turned its focus from the drugmakers to trying to determine the effect of a lighter, healthier population on demand for everything from hip and knee replacements to restaurants and snack foods. While the earnings impact is negligible at this point, many management teams spent a portion of their third-quarter earnings calls on the defensive, attempting to downplay the potential effects of the drugs on their businesses.
Nevertheless, Walmart conceded that shoppers who pick up a prescription for one of the GLP-1 drugs buy fewer units and slightly fewer calories than before. Those comments added additional pressure on food companies.
“Think the whole topic (of weight-loss drugs) has been overblown. We see absolutely no short-term impact on our results.”
Dirk Van de Put, CEO, Modelez International
4. The Appetite for AI Is Unabated
There’s no slowdown in the demand for technology to support the development and implementation of artificial intelligence (AI). It’s driving results and raising expectations for companies around the globe, ranging from software developers to providers of physical infrastructure such as servers, semiconductors and data centers.
During the quarter, Microsoft, Alphabet and SAP reported strong results from the cloud computing units where their AI investments are focused. Chipmaker Nvidia posted another quarter of strong earnings growth after seeing year-over-year revenue climb more than 200%.4 Meanwhile, Taiwan Semiconductor Manufacturing is just now getting a toehold in AI but reported growing demand for its AI-related semiconductors and better-than-expected sales of iPhone chips.
“I consider (client demand for technology) even greater today with generative AI and the proliferation of its use cases. Demand in this field of technology investment accelerated in the third quarter.”
Aiman Ezzat, CEO, Capgemini
Earnings Guidance Trending Lower Due to Economic Uncertainty
Not every company provides a forward-looking perspective on next quarter’s earnings. However, 66% of companies that have issued guidance provided lower-than-expected forecasts compared to 62% last quarter. The five-year average of companies issuing lower guidance is 59%.5
Analysts expect fourth-quarter earnings for the S&P 500® to be slightly positive before accelerating in the first quarter of 2024. Analysts expect input costs to continue normalizing and comparisons against the prior year to become easier. According to FactSet, the current estimates are for an increase of 3.2% in the fourth quarter and year-over-year growth of 0.6% for calendar year 2023.
In Europe, analysts estimate fourth-quarter earnings growth for Stoxx 600 companies to improve but remain in negative territory at -3.5%. For the 2023 calendar year, they estimate -0.5% earnings growth.6
Looking into 2024, current estimates call for U.S. earnings to grow 11.6% and sales to rise 5.5%.7 Though these estimates have been bullish talking points for stocks, many market participants view this rosy outlook skeptically. Risks include the aging business cycle, restrictive monetary policy, dampened fiscal support, global growth headwinds and the potential for disinflation to push down prices faster than companies can cut expenses.
FactSet, Refinitiv as of 11/14/2023.
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