by Michael Roberts
This week, we get the first US company reports on earnings for
the second quarter of 2019. And it looks as though there will be the
first back-to-back drop in overall earnings since the mini-recession of
2016. S&P 500 companies are expected to report an average earnings
fall of 2.8 per cent in the second quarter, according to data provider
FactSet, following a 0.3 per cent dip in the first three months of the
year.
Much is made of the large profits that the top tech companies, the so-called FAANGS,
make. But this hides the situation for the majority of US companies.
Those with a market value of $300m to $2bn look set to experience a 12%
drop in earnings from this time last year after a 17% drop in Q1 2019.
So small to medium size American companies are suffering a sharp profits
decline.
And even with the larger companies, profits are not as good as
portrayed. That’s because earnings per share have been boosted by the
large companies buying back their own shares (same earnings but with
less shares available). Net share buybacks are expected to contribute
2.1 percentage points to EPS growth in the second quarter, according to
analysts at Credit Suisse. US companies snapped up more than $1tn of
their own stock last year, a record figure, driven by the Trump tax
measures.
Underlying this decline in profits are higher wage costs as fuller
employment forces companies to concede wage increases to keep skilled
workers – it’s a different story with the less skilled outside the tech
sector. Also the cost of other non-labour inputs (energy, raw materials
etc) are rising. So profit margins (profits per unit of production)
are falling. Analysts expect non-financial companies to report net
margins of 10.8 per cent in the second quarter, down from 11.5 per cent
in the year-ago quarter, according to figures cited by BofA analysts. “We
have been highlighting risk to margins from rising input costs for
companies that don’t have pricing power, as well as for labour-intensive
companies and sectors amid rising wages, and we expect full-year net
margins to contract to 11.2 per cent in 2019 ex-financials from 11.7 per
cent in 2018,” they add.
The strong US dollar has also meant that US export companies are
finding it more difficult to sustain sales growth. S&P 500
companies are forecast to report a 3.7 per cent increase in revenues,
which would be the weakest growth since the third quarter of 2016.
Materials companies, the sector with the most sensitivity to China
and the fallout from the ongoing trade war between Washington and
Beijing, are expected to have had the toughest time in the second
quarter. DuPont and Freeport-McMoRan are expected to be the biggest
contributors to the sector’s earnings slump, according to FactSet. The
sector is projected to report a 16 per cent year-on-year decline in
earnings and a 14.9 per cent drop in revenues.
Most important, even the tech sector will experience an 11.9 per cent
fall in earnings and a 1.1 per cent drop in revenues. This is
important because it is this sector above all that has driven profits
growth in American companies over the period since the Great Recession.
If the FAANGS show a decline on profits, then American capital is in
trouble.
As James Montier, the post-Keynesian economist at GMO, the large
asset fund manager, points out, real earnings growth in the corporate
sector has been below the rate of real GDP growth even after the
significant boost from the financial engineering from share buybacks.
According to Montier, when you dig down into the market you find that a
staggering 25-30 per cent of firms are actually making a loss.
In Montier’s view, “the US is witnessing the rise of the “dual economy” — where productivity growth is reasonable in some sectors, and totally absent in others. Even in the sectors with good productivity growth, real wages are lagging (wage suppression is occurring). All
the employment growth we are seeing is coming from the low productivity
sectors. On top of this, the paltry gains in income that are being made
are all going to the top 10%. This is not what a booming economy should
feel like.”
There is a segregation of the US economy into sectors with reasonable
productivity growth and those with no productivity growth at all. The
single biggest driver of productivity is manufacturing, with information
and wholesale trade scoring respectably as well. On the least
productive side there’s transportation, accommodation, education and
healthcare. What’s more, in the laggard group, zero productivity growth
has gone hand in hand with zero real wage growth.
Not that this historic non-profitability has stopped investors from
piling into even more loss-making opportunities. According to Montier,
some 83 per cent of IPOs (new stock issues) this year have come to the
market with negative earnings. He stresses:”This is a higher percentage than that seen even at the height of the tech bubble!”
So the stock market rolls on upward to more record highs, floated by the expectation of yet more cheap or near zero cost money from the Federal Reserve.
But beneath the hype, the reality is that profits are falling for many
US companies, and over a quarter are making loss – in effect, they are ‘zombie companies’.
It is the same story in Europe and Japan. If the profits crash
materialises and is sustained through the year, a sharp fall in
investment and eventually employment and spending will follow, despite
the stock market boom – in effect a new recession.
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