If the Economy Is Shaky, Why Are Company Profits Still Strong? – The New York Times

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Corporate optimism may seem at odds with the Fed’s grim determination to hold back the economy to get inflation down, but earnings tell a story that other data doesn’t.
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Consumers are gloomy, the economy is shrinking, the Federal Reserve wants it to keep slowing and economists now say the whole world could be sliding toward recession.
At the same time, a lot of strong numbers are still coming out of many large American companies, which have been releasing their quarterly earnings reports and discussing their outlooks with Wall Street.
“We had an outstanding quarter,” Stephen Squeri, the chief executive of American Express, said after the company reported record revenue. “As our second-quarter results demonstrate, we have a lot to be proud of,” said Christopher Nassetta, chief executive of Hilton Worldwide, noting that revenue per room in most major regions of the world was now above 2019 levels.
The blustery corporate optimism may seem at odds with the Fed’s grim determination to hold back the economy to get inflation down. But the economy is both what the Fed does and how companies and consumers are behaving. And the full picture of this strange economic moment is perhaps better captured by considering both sides together, central bankers and C.E.O.s, no matter how divergent they seem.
Some big companies — Meta, for example — have reported disappointing numbers, and their chief executives are downbeat about the future. Other tech giants, Alphabet, Amazon, Apple and Microsoft included, all released results that, while hardly stellar, were enough to persuade investors that their businesses were not falling off a cliff.
Indeed, so far, with roughly half of all large companies having reported their numbers, this earnings season has not provided much evidence that the economy is entering a big crackup, and almost no chief executives talked about doing mass layoffs on earnings calls.
The lack of really bad news in earnings in part explains why the S&P 500 stock index has bounced about 12 percent from its low point in June, and why Wall Street analysts still predict that earnings for the companies in the S&P 500 will grow 10 percent this year, according to data from FactSet. Though much of that growth is expected to come from energy companies, which have benefited from higher oil and gas prices, analysts expect profits to rise in eight of the 11 industries represented in the index.
It’s an awfully rosy picture when “recession” is on people’s minds. That’s why for some on Wall Street, that optimism is absurd. Michael Burry, the investor who foresaw the 2008 mortgage meltdown, wrote on Twitter on Tuesday that the earnings reports coming in felt like a “last hurrah.”
Not done with fighting inflation, central banks are expected to continue pushing up the cost of borrowing, which would make corporate investments more expensive and dampen demand for companies’ products and services. Europe, a big market for U.S. corporations, could have a nightmare winter if natural gas prices continue rising. And supply chains are still dysfunctional for many companies, meaning they can’t even make and sell products for which there is demand.
“All those headwinds that created the downturn, they’re still intact and arguably getting worse,” said Mike O’Rourke, chief market strategist at JonesTrading.
Worrying outlook. Amid persistently high inflation, rising consumer prices and declining spending, the American economy is showing clear signs of slowing down, fueling concerns about a potential recession. Here are other eight measures signaling trouble ahead:
Retail sales. The latest report from the Commerce Department showed that retail sales fell 0.3 percent in May, and rose less in April than initially believed.
Consumer confidence. In June, the University of Michigan’s survey of consumer sentiment hit its lowest level in its 70-year history, with nearly half of respondents saying inflation is eroding their standard of living.
The housing market. Demand for real estate has decreased, and construction of new homes is slowing. These trends could continue as interest rates rise, and real estate companies, including Compass and Redfin, have laid off employees in anticipation of a downturn in the housing market.
Start-up funding. Investments in start-ups have declined to their lowest level since 2019, dropping 23 percent over the last three months, to $62.3 billion.
The stock market. The S&P 500 had its worst first half of a year since 1970, and it is down nearly 19 percent since January. Every sector of the index beyond energy is down from the beginning of the year.
Copper. A commodity seen by analysts as a measure of sentiment about the global economy — because of its widespread use in buildings, cars and other products — copper is down more than 20 percent since January, hitting a 17-month low on July 1.
Oil. Crude prices are up this year, in part because of supply constraints resulting from Russia’s invasion of Ukraine, but they have recently started to waver as investors worry about growth.
The bond market. Long-term interest rates in government bonds have fallen below short-term rates, an unusual occurrence that traders call a yield-curve inversion. It suggests that bond investors are expecting an economic slowdown.
Things could go into reverse quickly, the pessimists say. Many companies have for some time lived in a sort of nirvana in which they could keep hoisting their prices and customers would keep paying them, creating blowout profits.
Now there are signs that consumers are balking at what companies charge, and if they pull back hard, their sales and earnings could take a big hit and lead chief executives to lay off workers and slash investments to protect profit margins and balance sheets. Early signs of this dynamic are emerging, according to some analysts.
Home-building companies, for instance, have been able to sell homes at ever higher prices over the past two years, but as the Fed has raised interest rates, their senior executives say demand has fallen.
PulteGroup, a large home builder that reported earnings this past week, said the average price of its homes in the second quarter was $531,000, a 19 percent increase from a year earlier. The company forecast that the average would keep rising this year. At the same time, Pulte said, net new orders plunged 23 percent from a year earlier, which the company blamed on the increase in mortgage rates.
“We’ll have to see how well the sector is able to hold on to those price increases that they’ve accumulated over the last couple of years,” said Brian Barnhurst, co-head of credit research for PGIM Fixed Income, a division of Prudential, referring to home builders.
Pulte did not respond to requests for comment.
While well-off consumers show few signs of cutting back, the second-quarter earnings contain plenty of evidence that some households are getting squeezed as inflation pushes up their bills.
AT&T said its customers were taking two days longer on average to pay their bills, which caused a hit to the phone company’s second-quarter cash flow of almost $1 billion. The company’s chief executive, John Stankey, said on the earnings call that bad-debt levels were slightly higher than before the pandemic. But he added, “We view this cycle no differently and still expect customers will pay their bills, albeit a little less timely.”
On the earnings call for McDonald’s, the company’s chief financial officer said some of its customers were choosing “value” offerings over others. On Chipotle’s earnings call, its chief executive, Brian Niccol, said: “The low-income consumer definitely has pulled back their purchase frequency. Fortunately, for Chipotle, that is not the majority of our customers.”
Big retailers like Walmart have said their customers are spending so much on must-have items like food and fuel that they’re eschewing higher-cost merchandise, like clothes and home goods. Since shoppers are still spending at Walmart for the staples, the company — and to a certain extent, the economy — still benefits from their purchases, though the shift has hit its profit margins and helped pummel its stock.
Banks earnings are a good place to get an early read on how consumers are faring. Overall, there are few signs at lenders that borrowers are having trouble repaying their loans, analysts say.
“You would have come away from the quarterly earnings thinking that the consumer was generally in good shape,” said Moshe Orenbuch, an analyst who covers finance companies at Credit Suisse.
Because of pandemic stimulus payments, low unemployment and rising wages, the levels of past-due loans and bad debt fell to historical lows, but lenders have expected them to rise as borrowers reduce cash holdings and their balance sheets look more like they did before the pandemic. The finance industry has started calling that process “normalization.”
It appears to have begun among lower-income borrowers.
Richard Fairbank, the chief executive of Capital One, a big credit card lender, said on the company’s earnings call that this normalization was more evident in the bank’s subprime loans than in those made to borrowers with stronger credit. But Capital One declined to provide past-due loan numbers for its subprime loans, making it impossible to chart the extent of any deterioration.
In its earnings report, Ally Bank, a big auto loan maker, provided data on past-due auto loans in the second quarter for borrowers at a range of income levels. Past-due loans were either at or close to prepandemic levels for borrowers with lower incomes.
Ally declined to provide the same data for earlier quarters, making it impossible to know how quickly past-due loans might have risen. On its earnings call, Jenn LaClair, Ally’s chief financial officer, said, “We have continued to invest in talent and technology to enhance our servicing and collection capabilities and remain confident in our ability to effectively manage credit in a variety of environments.”
Some analysts think the pullback in spending could spread to wealthier households.
“You’re going to see it go up the income scale as the year unfolds with people sitting there, saying, ‘I’ll go without rather than spend this much on that’ or ‘I’ll trade down to something more affordable,’” said Mr. O’Rourke, the JonesTrading strategist. He added that he was waiting for earnings from Macy’s and Nordstrom, which are scheduled to report in August, to see if that was happening.
The concern is that the heavy summer spending that has recently bolstered the earnings of the hospitality industries and the airlines is not sustainable. “There’s a faction of the market that’s quite convinced that when we get to the fall and the bills from the summer spending come home to roost, the consumer will be in a much trickier spot,” Mr. Barnhurst of PGIM said.
An exchange this earnings season reveals how chief executives and companies can keep the economy going, even when they fear that a downturn may be at hand.
Jamie Dimon, the chief executive of JPMorgan Chase, warned in May that storm clouds were gathering over the economy. On JPMorgan’s second-quarter earnings call, Mike Mayo, an analyst at Wells Fargo, asked Mr. Dimon why the bank had committed to investing such large sums this year if things could turn dire.
“It’s like you’re acting like there’s sunny skies ahead,” Mr. Mayo said, “You’re out buying kayaks, surfboards, wave runners just before the storm. So is it tough times or not?”
Mr. Dimon’s response: “We’ve always run the company consistently, investing, doing this stuff through storms.”
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