As we filter through a swathe of Black Friday promotions, signalling that the festive period is well and truly upon us, we use this opportunity to wrap up the US earnings season.
While companies can report on any quarterly cycle of their choosing, the majority arrange theirs to align with the calendar quarters. This means that the four-week period between the results of JP Morgan and Walmart – the unofficial beginning and end of the earnings season – is a somewhat hectic time for analysts and portfolio managers alike. Both take time to parse results and attempt to detect trends that will give us a hint as to the health of the companies themselves and the broader economy. The reported numbers and the conference call between company management and the market provide interesting, if sometimes conflicting, datapoints that are discussed and debated at length.
… but the United States Generally Accepted Accounting Principles (GAAP) leave a significant amount of room for corporate discretion in reporting. According to the most recent report from FactSet, approximately 70% of companies reporting in the Q3 period have surprised the market with earnings in excess of expectations, with slightly more companies surprising on revenue. This offsets some major disappointments, particularly from the large technology companies. Meta Platforms (formerly Facebook) reported results materially below the market’s expectation and guided investors to expect lower profits going forward due to investments. Alphabet also disappointed the market with a weaker than expected advertising result. In a sign that the market can sometimes be churlish, Microsoft experienced a 7.7% price decline the day it announced that revenue growth in the core Azure cloud computing franchise had reduced from 46% (in constant currency) to 42%, a growth rate that most CEOs dream of.
Whilst it is undoubtedly positive that corporate America remains more resilient than the market expects, the rate of earnings growth has decelerated from recent periods. This is unsurprising as comparisons with the same period one year ago are now much more difficult to exceed. This time last year the impact of reopening boosted reported results and this run rate is impossible to maintain. In addition, rising inflation and interest rates have suppressed corporate margins, as some companies have been unable to raise prices enough to offset the rate of inflation in their cost lines. Equally, higher interest costs for companies that have variable debt or need to finance via debt have reduced profits available for shareholders.
Below the index level there is yet more nuance. Given the strength of oil prices this year, Energy has led the market in terms of earnings growth, with a blended earnings growth rate of 137.3%[1]. The leading detractor was the Financials sector, with rising bond yields, economic uncertainty and poor market returns combining for a poor operating environment. However, one specific requirement of GAAP drove the banking sector to an uninspiring return. Banks must make provisions for debt that they believe may not be repaid. At the outset of the pandemic, the banks made large provisions and have been reversing these as stimulus programmes and excess savings have resulted in low levels of bad debt. This quarter the banks returned to a normal (pre-pandemic) level of provisions; Bank of America made a provision of $898m this quarter, having released $1.1bn in the third quarter of 2021. This has no impact on the operating result of the company but does impact reported earnings.
Most companies host a conference call for the market the day they report earnings. The highlight of these calls tends to be the Q&A, where analysts can delve into detail they feel may be missing or ask for information about trends they are seeing in the operating environment. Executives may also comment on trading post the reporting date (in this case 30 September). Although every sector and company has its own trends, there are some macroeconomic themes that tend to run through the earnings season.
The theme of this season, once again, was recession. However, and perhaps counterintuitively, the number of companies mentioning the word "recession" in conference calls declined by 26% this quarter relative to the last according to FactSet. Of course any search of this nature will miss the nuance, but it is interesting to note a material step down in discussion of this nature.
One reason may be that some of the larger bellwethers have stated they see no signs of recession in their operations. As well as bookending the earnings season, the market looks towards the banks and the retailers for commentary on the state of the economy. The executives of JP Morgan stated that across their business they are not seeing any signs of a recession, some of normalisation but even that being slower than expected internally. Interestingly, there was less challenge on the call from analysts, who spent the majority of the second quarter call challenging the company’s economic outlook. There was no mention of the word "recession" at all in the Walmart presentation, who despite noting economic uncertainty and more cost-conscious behaviour from customers, upgraded their guidance to the market. By and large, corporate America is saying that while conditions can change quickly, there is as yet no evident recession in the USA.
It has felt all year that the market has been looking to the upcoming earnings season to show the cracks in the economy which, at this stage, have failed to materialise. After 18 months of consistently high earnings, as the corporate world has benefitted from reopening and the easy comparison to earnings of the previous year, it was natural that results would begin to be less positive. Whilst we can see some clouds on the horizon, the quarter just reported has shown that the private sector remains resilient.
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