Market Overview
Discerning earnings
Second-quarter earnings appear to be weaker than normal, analytics firm FactSet reports. Upside surprises are comparatively rare, except for some shining examples from the S&P 500’s Health Care sector. As for the Energy sector, the reason why there were few surprises there is that these companies kept revising their estimates upward throughout the quarter.
“Despite the below-average performance relative to estimates, the index has a higher earnings growth rate for the second quarter,” according to FactSet’s John Butters, noting that the blended earnings growth rate for the spring quarter was 4.8%.
The data from FactSet illustrated how there was earnings growth in Industrials, Materials, Real Estate and Information Technology, as well as in Energy and Health Care. Meanwhile, Consumer Staples, Utilities, Communication Services, Consumer Discretionary and Financials all disappointed.
Top-line growth
None of these variances in sector earnings is unusual. Different sectors outperform others at different points in the economic cycle and, with all the recessionary signals abounding it stands to reason that, for instance, the Consumer Discretionary sector might lag. As bank borrowing costs increase, but their need to compete for new homebuyers keeps their mortgage rates low, the earnings from the Financials sector is bound to fall short.
But what is unusual is the top-line growth. Every sector – every single sector – has successfully pushed through price increases. As we all know, energy bills have gone up close to 56%, but most other businesses have also seen revenue growth exceeding or at least approaching the rate of inflation. Financials and Utilities haven’t kept pace, but even those sectors have eked out a couple percentage points’ sales gains.
Buying time
You’ve probably complained a lot about inflation the past few months. Everyone has. We have. But have you actually changed your buying behaviors?
Probably not, according to one study.
Markups – the difference between prices charged at checkout and the marginal costs incurred by a company in order to make a product—climbed about 25% between 2006 and 2019, according to Alexander J. MacKay, an assistant professor at Harvard Business School.
“Despite the steady increase, shoppers still bought their favorite breakfast cereals, paper towels, and other consumer goods during the decade and a half before the pandemic began,” according to a summary of MacKay’s research, which sheds light on how markups on key household items had already taken off long before Covid-19 was a thing. “Consumers were 30% less price sensitive … in 2019 than they were in 2006.”
The more things stay the same
S&P 500 executives must have already known this. One consumer watchdog group, Accountable.US, called out such retailers as CVS, Kroger, T.J. Maxx and Home Depot for using widespread inflation as cover for raising their prices excessively.
Of course, the retailers have their side of the story too.
"As our customers advocate for value, we're continuously working with our suppliers to keep costs as low as possible for our customers," Home Depot told CBS News in a statement. "Our growth has been based on overwhelming demand in home improvement."
Also, going on the widely held assumption that a recession is imminent, it just makes sense for these companies to push through increases now while they still can.
“Trying to catch up on pricing in a recessionary environment is very hard,” Coca-Cola CEO James Quincey told investors. “And so we have a bias to action.”
Even so, it’s hard to square the S&P 500’s rise in top-line revenue with its mediocre bottom-line income. The companies that will continue to thrive during an economic downturn will be those who are able to not only pass along their higher operating and inventory prices, but also be able to improve their margins while doing so. A financial advisor who’s been in the business long enough to learn the lessons of a high-inflation environment might prove invaluable to helping you pick the winners.
