After a bumper 2021, companies may struggle to boost profits

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The profit engine that has driven stocks to their peaks, making many Americans feel richer than they have been in a generation, may now be working in reverse.

Companies like Snap, Cisco Systems, Deere, Walmart and Target warned investors of the challenges their businesses face, sending their stocks tumbling and contributing to a fall that sent the S&P 500 index down about 13 % from its January peak.

Sharp declines in the stock market came after investors began to worry that the Federal Reserve would rein in the economy to bring inflation under control by raising rates and ending its asset purchases. Central bank decisions could cause corporate earnings to plummet, which is what investors are ultimately most interested in.

Investors are hoping the Fed can pull off a soft landing, bringing inflation down without widespread economic damage. But the recent flurry of lackluster corporate financial reports suggests the economy has already deteriorated – and more companies will announce business slowdowns.

“There is a tremendous amount of uncertainty,” said Mike O’Rourke, chief market strategist at JonesTrading. “I think things will weaken.”

Snap, known for its Snapchat app, last week warned investors of a sharp deterioration in its business, which depends almost entirely on the sale of ads. “Since we issued guidance on April 21, 2022, the macroeconomic environment has deteriorated further and faster than expected,” Snap CFO Derek Andersen wrote in a financial filing. Its stock is down 31% since the news.

Such warnings come after a year of record profits in corporate America.

Loose monetary policy and strong government spending helped many S&P 500 companies in 2021. And some companies posted higher profits because the prices of goods that were in high demand and in short supply rose a lot, often more than to compensate for the fact that the companies sold less goods.

S&P 500 company earnings rose 70% from 2020 – a rebound from depressed earnings at the start of the pandemic – and 33% more than 2019, which was a fairly good year for corporate profits. companies.

But something else happened last year to create the boon – and now that development may be playing out.

A New York Times analysis of more than 2,000 publicly traded companies outside the financial sector found that most were growing sales faster than expenses, a remarkable feat when the cost of wages, materials raw materials and components were increasing and supply chains were out of whack.

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As a result, profit margins, which measure how much money a business makes on every dollar of sales, have increased well above the pre-pandemic average. Overall, companies made about $200 billion in additional operating profits last year because of these increased margins.

The windfall sent stocks surging in a wave of market exuberance, but potentially beyond what the company’s fundamentals deserved. The price-to-earnings ratio — a gauge of how much investors pay for every dollar of corporate profit — for all S&P 500 companies jumped to 23 at its peak, from an average of 18 for the decade before the pandemic. With such a high price-to-earnings ratio, stock prices were particularly vulnerable to a sell-off.

And now investors have good reason to be concerned about profits. Many federal stimulus programs created during the pandemic have ended or are winding down. The Fed raises its interest rates. And business executives are warning that supply chain issues that may have helped boost their profits last year have become a burden.

Deere, the maker of agriculture, construction, gardening and other equipment, said material costs continued to rise and there were a shortage of parts to complete some products, which was holding up sales. Cisco, which manufactures computer networking equipment, also complained that it could not obtain certain components.

Signs that demand for certain goods and services is stabilizing or even declining are particularly worrisome for investors. Walmart noted that higher food costs appeared to have reduced demand for other items. And while Target expected demand for apparel and home goods to fall as government stimulus measures wear off, the company “didn’t anticipate the magnitude of that change,” said its general manager, Brian Cornell.

Shares of clothing retailer Gap fell sharply last week after reporting disappointing results for the first three months of the year, as well as a more pessimistic outlook for its earnings through the rest of 2022. The company was heavily impacted by a sharp drop in sales for its Old Navy brand, which tends to appeal to lower-income consumers as it offers merchandise at lower prices than Gap stores.

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“We’re dealing with very volatile consumer signals – whether it’s last year at Covid or post-Covid behaviors this year,” Sonia Syngal, Gap’s chief executive, told TAUT in an interview.

Many retailers face a similar challenge: higher inventory and lower sales drive them to offer discounted products, which squeezes profit margins. In fact, bad news for corporate earnings could be good news for the inflation outlook, as the prices of at least some goods fall back to earth.

That said, many companies performed well in the first three months of the year and offered upbeat projections for the rest.

According to S&P, only 97 of S&P 500 companies reported earnings below analysts’ expectations and 375 companies beat them.

Shares of Macy’s and Dollar General surged on Thursday after company executives gave an optimistic outlook. “As macroeconomic pressures on consumer spending increased during the quarter, our customers continued to shop,” Macy’s said in a statement. The retail chain raised its profit forecast for the year.

Even Deere and Cisco – two companies that have warned of supply chain issues – said there was no slump in demand for their products.

Wall Street analysts, generally optimistic, remain so now. They cut their profit projections for some sectors – companies selling larger items to consumers and industrial firms – but raised them for others, energy in particular. Even as economic uncertainty has deepened, analysts have steadily raised their forecasts for full-year earnings for all S&P 500 companies and expect earnings to rise 10% this year and next, according to data. FactSet data.

But Mr O’Rourke said analysts generally do not cut estimates until companies issue public warnings that business is beginning to deteriorate. Such warnings may not materialize until second quarter results are released from July.

“Analysts in general know the numbers have to come down,” O’Rourke said. “They just want something to build on.”

For now, many analysts and business executives say they are not worried about demand. They say individuals and businesses have plenty of money to buy goods and services, even with higher interest rates.

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A recently released survey the Fed conducted in the fall highlighted the dissonance between weak consumer sentiment as measured by the University of Michigan or the Conference Board and the strength of household bank accounts.

The Fed found that the share of adults who said they had the money to cover a $400 emergency expense had risen to its highest level since the survey began in 2013 — 68%. Fed officials declined to speculate on the effects of high inflation on this measure.

Worries that spikes in food and fuel prices could force American families to drastically cut back on discretionary purchases have been partly alleviated by recent data. Retail sales hit a new high in April, while activity in industrial production also hit a record high last month.

Even though lower-income households have depleted much of their pandemic-era savings, it is possible that those with higher incomes can help sustain increased levels of consumer spending. Many people are eager to travel now that the coronavirus pandemic has generally faded as a life-altering concern for many families. United Airlines, Southwest Airlines and JetBlue said this month that their second-quarter revenues would be higher than expected.

Morgan Stanley analysts noted that while low-income households would be hardest hit by inflation, they accounted for a relatively small share of consumption in the economy. Households in the bottom 60% of the income distribution typically account for less than 40% of total spending, analysts found, while the top 40% account for more than 60% of spending.

Jim Paulsen, chief market strategist at Leuthold Group, said financial conditions have been tightening for some time and inflation is likely to moderate soon. This, he said, would make consumers feel better about the economy and give them more purchasing power.

In a market bathed in pessimism, any good news could send stocks higher, Paulsen said. “Our hope has been destroyed,” he said. “And it’s a bull market feast. This is where the bears die.

The S&P 500 closed up 6.6% last week.

The message After a 2021 bumper, companies may struggle to boost profits appeared first on The New York Times.

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