As the second quarter company earnings season closes out, it provides a good window on to what’s actually happening on the ground in the US economy.Rather than listen to the economists and analysts, we can hear what the women and men who actually run companies, and have to report to shareholders, think where we are in this business cycle.
The numbers are less important than what forward guidance is given by management, and what answers are given in post announcement briefings. The earnings numbers themselves are part of a highly choreographed exercise to make sure market expectations are not out of synch with economic reality.
So, what can we tell from what CEOs are saying?
Profit margins are under pressure.
This is the second quarter when year on year margin comparisons are negative for most sectors – Energy being a major exception.
Higher material costs, higher transport and labour costs are quite a common feature in what executives managers have to say.
Domino’s Pizza, for example, faced with higher energy prices, higher flour costs, and shortage of drivers have actually had to discount to retain demand. Naturally this hits margins – for the pizza maker gross margins fell this quarter from 40% to 36%.
Can anyone pass on cost increases to customer prices and preserve margins? Pepsico, maker of Quaker Oats and Frito-Lay, one of the earlier companies to announce, pointed to their core business where price increases were having no negative impact on demand. They have increased prices twice already and see more room to go further if required. There is a similar story over at Coca Cola where CEO James Quincey spoke about their ability to push price increases through to offset the rise in fructose, aluminium and transport costs, but he cautioned that there will be limits to doing this continuously. Unilever also spoke about being able to pass price increases through on a lot of their premium brands.
Despite what may be near term recessionary fears, companies continue to invest – especially in technology and especially in the “Cloud”. We can see this in the numbers from some of the companies which often facilitate that investment. IBM. In this quarter, saw robust demand growth, making for double digit performance from its consulting side. This cloud migration theme was backed up by very strong numbers from Microsoft coupled with a very positive outcome.
What about the health of the economy overall? Most companies refer to macro-economic challenges. But is the US entering a full-blown recession?
Well a lot depends who you listen to. Many companies are cautious. Apple for example, well in advance of their announcement, surprised the market, saying they would look to slow-down hiring and spending in 2023 to cope with potential economic down-turn. It wouldn’t however be company-wide but in selected teams.
But it’s not universal and many CEOs speak of resilience in the economy and notably the consumer. General Motors, historically a bellwether stock for the US economy, speaks of robust demand and a strong pricing environment and in fact didn’t have enough vehicles to meet demand. This positive view on the all-important US consumer was repeated by many of the main street banks. Looking through what was said at press conferences, the message was not to jump on the recession bandwagon just yet – at least not a consumer-led one.
Citigroup CEO Jane Fraser said little of the data she sees suggests a US economy on the brink of a recession, with strong household savings providing a “cushion for future stress”. Jamie Dimon, CEO of JP Morgan, thinks the consumer is in great shape. Even low income households have cash balances 70% higher than in 2019. And as for business credit, Dimon thinks it has never been better “in our lifetimes”.
So what’s the picture from what managers are saying in this US earnings quarter.
Some companies are able to pass on price increases to their customers and thereby ease some margin concerns. Others are less well positioned.
But the most important thing seems to be this – the consumer appears to be in good shape – certainly much better than when the economy flirted with downturns on previous occasions.
This may well be the vital difference that means any US economic downturn could be shallow.
Tradewinds 