Saturday, December 10, 2022

Beating Expectations Isn’t What It Used To Be

CEOs are in the middle of telling us about how 2021 was for them, and they seem to be scarcely more than a sideshow. The excitement of the year so far in the stock market has been almost entirely driven from the top down, as everyone realizes they need to worry about inflation and rates. In that context, earnings have struggled for attention. But it’s perhaps telling that those earnings have been very respectable so far — and haven’t as yet managed to bring stocks back into the black for the year.

Looking more broadly, the ground lost during the pandemic has been made up and earnings are now growing ahead of the longer-term trend, which has seen S&P earnings growth average about 6.5% per year for decades — one of the key reasons stocks have performed so well in the long run. While it’s good that the corporate sector has managed to survive an epic economic shock with minimal damage to profits, it might be a concern that they begin to look unsustainably ahead of their trend. That’s implied by these charts produced by Bankim Chadha, asset allocation strategist at Deutsche Bank AG, who takes the trend in S&P 500 earnings back to 1976:

Compared to expectations, companies are as usual managing to come up with a little more in the way of profits than they had previously briefed Wall Street to expect:

Savita Subramanian, quantitative strategist at Bank of America Corp., shows that the underlying trend in both earnings and sales announcements is that investors have caught up with the reality of post-pandemic earnings growth. After four successive quarters in which forecasts were being almost constantly upgraded (and providing some great fuel for the overall market in the process), markets are no longer needing to make up lost ground. The great catch-up trade of 2021 is over:

This isnt the only extra twist to the old and tired game of earnings management. Investor relations departments know how to set a lower bar for themselves to “beat expectations” on announcement day. But the pandemic rebound created an implicit expectation to be surprised (yes, that’s a contradiction in logic, but people still expected to be surprised) that grew ever greater. That era is finished. Meanwhile, the market is showing much more of a penchant to punish “misses” than it usually does. For a chief financial officer, the risks are asymmetric. To quote Chadha of Deutsche Bank:

After Tuesday’s close, PayPal Holdings Inc. joined the ranks of companies to be punished for disappointment, with an after-market fall of almost 20% — but Alphabet Inc., the parent of Google, showed there could be rewards for strong results with an after-hours gain of more than 7 %.

Why are investors so unwilling to get excited? In part, it’s because chief executives aren’t trying to excite them and are instead talking down their prospects. This is honest, and what they should do, but it never goes down well. Thus, as the prospective earnings for the quarter just ended have risen, hopes for the current quarter have stagnated, as illustrated by Andrew Lapthorne, chief quantitative strategist at Societe Generale SA:

With modern data-crunching techniques, it’s possible to quantify the assessments that CEOs are offering. In general, they don’t inspire great confidence on the crucial macroeconomic issue of inflation, and the related corporate one of margins. For example, Subramanian shows that executives are no longer mentioning prices (and their chances to raise them) any more than wages (and the risk they will have to raise them) — and this turns out to be a bad sign for margins:

Executives are also spending somewhat less time kvetching about the obvious concern of supply chain problems. But in general they aren’t assuring their investors that the worst is over, and instead are making rather more bearish comments. One particular morsel, cited by Subramanian, is worth quoting at length. It comes from the earnings call given by PPG Industries Inc., the paint and coatings manufacturer:

When business execs closest to the action are giving us lessons like that in the difficulties of a world still marked by the pandemic (and there are many other examples), it’s not surprising that decent earnings haven’t helped prop up share prices as much as they usually might.

With the first of the month, we embark on another ream of data. Nothing as yet answers the critical question of whether inflation will come down obediently without too much aggressive monetary intervention, but there are plenty of clues.

One positive sign is in the San Francisco Fed’s classification of inflation into categories sensitive to the pandemic and other sectors relatively unaffected by it. Early last year, it was Covid-sensitive prices that took off, which is what might be expected. Since then, the good news is that Covid-insensitive inflation actually dipped in December and shows no obvious sign of breaking out — but that’s tempered by a continuing rise for Covid-sensitive items. A quick resolution to the pandemic would, among many other good things, help to control inflation:

Meanwhile, publication of ISM surveys of supply managers in manufacturing around the world confirmed the expectation that growth was continuing, but at a slightly slower rate. Omicron confuses the picture, of course, but it looks as though it has had an effect, if not as severe as was feared two months ago.

However, the surveys on prices that businesses are paying, and the delivery delays they’re experiencing, are on disappointing balance. Prices, a good leading indicator for inflation, are below the all-time high they set last year but actually rose last month. The improvement in delivery delays stalled in January. Presumably omicron was the culprit, but that means uncertainty goes unresolved. If inflationary pressures in manufacturing have peaked, and it looks as though they have, it’s disappointing to see that they’re not being reduced quickly:

Meanwhile, the most concerning numbers were on the labor market. The Bureau of Labor Statistics published figures on job openings (known as the JOLTS) with a lag, so this is backward-looking data taking the story only to the end of December. It’s possible things have already improved. But the telling statistic is that job vacancies outnumber people looking for jobs by the greatest amount since the series started:

Numbers like this explain why CEOs have tended to be rather downbeat about wage bills in their conference calls.

The pandemic and the layoffs that accompanied it put the labor market in unprecedented territory. It’s possible that this can be swiftly resolved as normality returns. But on the face of it, this would explain why Jerome Powell of the Federal Reserve has sounded so worried about the labor market. It also suggests that he’s right to worry.

There’s plenty more data ahead in the next few days — but it’s ever-clearer that we’ll have to brace for many unhappy hours going through the statistical entrails this year. It’s far less clear how great the inflationary problem will prove to be.

For some reason, Apple Music’s algorithm asked me to listen to Tanita Tikaram the other day. She has an extraordinary voice and was a big deal when she broke through in the late 1980s, and I’ve no idea why she didn’t go on to be a major star. Try listening to Good Tradition or Twist In My Sobriety. Other notable female singers whose careers weren’t as successful as they probably ought to have been: Judie Tzuke, Annie Haslam of Renaissance, Hazel O’Connor, Justine Frischmann of Elastica, and The Passions’ Barbara Gogan. Some successful singers who deserve a lot more recognition than they might include Beth Orton, PJ Harvey, and the Cocteau Twins’ Elizabeth Fraser (whose name I include as an excuse to link to the masterpiece Teardrop, by Massive Attack, which has been covered by some very exciting singers of the current generation).

More From Other Writers at Bloomberg Opinion:

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

John Authors is a senior editor for markets. Before Bloomberg, he spent 29 years with the Financial Times, where he was head of the Lex Column and chief markets commentator. He is the author of “The Fearful Rise of Markets” and other books.


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