Pricing power and earnings growth
The commentary around stock markets is almost universally gloomy. Against a backdrop of higher inflation and rising interest rates, making progress is challenging. However company earnings are seemingly one bright spot – and it is possible they will sustain their strength in spite of the weakening macroeconomic environment.
Over 2022, we’ve seen relatively resilient earnings growth. Certainly, there have been some downgrades, but corporate pricing power has offset higher input costs in many cases. When we divide sales into volume and value, we see that volumes are slowing, but the value of revenues is still growing. Companies are managing to put through higher prices in response to higher input costs. Multinational consumer goods company Unilever is an example. In the third quarter of 2022, the company was able to raise prices by 12.6% from a year ago, more than offsetting a 1.6% decline in sales volumes . This resulted in a steady acceleration in sales revenue throughout 2022.
In the US, price rises are higher than the corresponding rise in input costs. In aggregate, we have seen prices rise by 10.4%, but unit labour costs have only risen by 8.3% . In other words, companies are charging more than they need to offset the increase in the cost of labour. Admittedly, this is only an option open to companies with pricing power, but while we see a cost-of-living crisis for individuals, there has been a boom for some businesses, particularly among larger listed companies.
This has led to a robust earnings outlook. In aggregate, analysts are now expecting growth of 4.5% for 2023 and 8.6% for 2024 . Some have suggested that these predictions are optimistic and do not take sufficient account of the shifting macroeconomic landscape, but it may just be that prices have held up well and analysts expect this to continue. To our mind, they look realistic, as long as there are no significant surprises lurking.
What are the risks to earnings expectations?
There are risks to earnings expectations, particularly if the global economy enters a recession. The global Purchasing Managers Index (PMI) data, a measure of the prevailing direction of economic trends in manufacturing and of corporate confidence, saw a steady deterioration. Globally the PMI peaked at around 53, and has subsequently decelerated to 49.3, anything below 50 points to an economy in contraction . The US is still above this important figure. China remains the swing factor and the key area to watch.
If China doesn’t open up and the eurozone continues to be weak, earnings could dip lower and weaken equity markets. Even in a worst-case scenario, the downside risk to stock markets may be relatively muted. A lot of the price movement has already happened as valuations have adjusted and a lot of negative news is already in the price of shares.
Rays of light
In contrast, if the Federal Reserve were to soften its position on interest-rate tightening, earnings growth could improve. Equally, the strength of the banking sector may help support earnings. There is less leverage in the system than there was in 2009. Banks are generally well capitalised and loan growth continues to be strong, particularly in the US.
Many companies took the opportunity to re-finance their debt extending the maturities during the pandemic. As such, only around 15% of US corporate debt (including floating) that is due to be refinanced by the end of 2023 is affected by rising interest rates. The impact of the changing interest-rate environment on US corporate earnings is therefore likely to be minimal, at less than one percentage point of earnings .
The strong US dollar could continue to weigh on US corporate earnings growth, as overseas’ earnings will be worth less when translated back to the US. In its Q4 earnings report, Apple said that the dollar had exerted a significant drag, costing it over 6% of earnings growth . This is a pattern replicated for many US companies operating internationally and is a headwind that may persist into 2023.
We continue to focus on more defensive sectors, believing that is where the greatest earnings resilience will be found. That includes healthcare, staples, utilities, and energy companies.
 Refinitiv/ Evelyn Partners
 Apple beats but comes up light on iPhone sales and services, CNBC, 27 October 2022
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