As of May 12, 2022, over 91% of S&P 500 Index companies have reported first quarter 2022 earnings results.1 The earnings per share growth rate versus one year ago stands at 9.66%.1
However, pandemic impacts are still glaring.
The sector with the worst growth rate during the first quarter is Consumer Discretionary. Earnings have fallen -47% versus a year ago.1 Most of this decline can be blamed on the internet retailers. This is no surprise as these companies had incredible growth during 2021 while people were still staying home. Now consumers have wider spending choices when it comes to goods and services. We can go out and buy things and travel rather than being limited to what can be delivered to our front door. On the flip side, the sector with the fastest earnings growth this quarter was Energy at 268%.1 It’s the exact opposite of Consumer Discretionary. Energy companies as a sector lost money, a lot of money, in 2020 and 2021. Now their earnings are rebounding.
S&P 500 Index earnings per share for 2022 are now expected to grow 9.96% as compared to a growth expectation of 7.34% on December 31, 2021.1 This higher expectation versus the beginning of the year is thanks to an improved earnings outlook for the Energy, Technology, Materials, and Real Estate sectors.
Profit margins overall are steady, even as input prices and employment costs have risen at a dizzying pace over the past year.
How is this?
The yellow line (sales growth) in the chart below explains. Even though Producer Prices (PPI, red line) and Employment Costs (ECI, purple line) have accelerated, the growth in sales (yellow line) has been even faster. Companies can maintain profit margins when this relationship holds. But notice how the yellow line has begun to slow. This is the impact on demand as financial conditions tighten and the Federal Reserve raises interest rates.
Demand needs to slow.
We showed in our Investment Insights dated April 5, 2022, how consumer demand had far exceeded industrial production for consumer goods. Yes, supply chains are a problem, but demand appeared to be more of a problem. In the spirit of tackling the problem immediately in front of you (and the one you can impact), the Fed took on the task. Now we are now seeing demand slow in various places throughout the economy. The chart above showing sales growth demonstrates slowing demand. The chart below shows more detail. It’s easy to see the pandemic stimulus effect. Real disposable personal income is what consumers have left to spend after their necessities are paid and inflation is subtracted. The blue bars, red line, and purple line are normally steady. The first pandemic stimulus is the first spike in the blue bar. It produced a large percentage change in income compared to a year ago. Then we went two quarters with no stimulus and consumers felt the full impact of rapidly rising unemployment.
The second stimulus caused another income surge compared to the prior year.
Since then, fiscal (government) stimulus has ceased and the blue bars representing the yearly percentage change in real disposable personal income have become negative.
The behavior of spending (purple line) and saving (red line) is interesting. Consumers cut back on spending and saved the first stimulus. It was early in the pandemic and there was great uncertainty. The second stimulus produced a little bump in savings, but a larger increase in spending. People were obviously more confident, and this helps explain the sudden increase in demand for consumer goods. But now, the savings rate has returned to normal and real personal consumption expenditures (after the impact of inflation) have turned negative. People are spending less of their disposable income. This normally happens when the necessities of life require more of a paycheck. It’s not difficult to imagine how high food, energy, and housing costs may be exerting a negative impact here.
If the demand side is weakening, shouldn’t we expect inflation to slow as well?
Yes, normally that would be the expectation. The recently released Consumer Price Index (CPI) did show price declines in used cars and clothing.2 But it’s the less discretionary items that have markets keenly tuned into when, or if, input costs fall. Federal Reserve Chairman Jay Powell acknowledged this situation as he granted interviews after the latest Fed meeting. In an interview with Bloomberg News on May 12, Chairman Powell said, “The question whether we can execute a soft landing or not, it may depend on factors that we don’t control.”3
Chairman Powell is referencing supply and other structural, rather than cyclical, issues within the global economy. These supply and structural issues are much less sensitive to reductions in demand. A great example is within the gasoline and diesel fuel markets. Yes, higher oil prices are certainly a large factor, but geopolitical logistics and refining capacity are also at play. Each month, the Energy Information Agency (EIA) releases its Short-Term Energy Outlook that details current energy market conditions along with some future forecasts. An excerpt from the EIA’s May 5, 2022 report is below. You can find the weblink to the full report in the footnotes of this document.
“High global demand and low inventories continued to support higher distillate prices and crack spreads in April. Distillate exports from Russia have declined as a result of sanctions. This drop in global supply, combined with refinery closures over the past few years, has produced a tight U.S. distillate market. U.S. distillate stocks declined by 9.4 million barrels (8%) from March, falling to 24% below the five-year average. Increased trucking activity and increased distillate demand for oil and natural gas drilling could be contributing to higher domestic diesel demand and supporting ULSD (ultra low sulfur diesel) prices. In addition, distillate exports are contributing to lower stock levels. Our estimate for April net distillate exports of 1.3 million b/d, if confirmed in monthly data, would be the highest amount of net distillate exports since September 2019.”4
Energy prices are normally sensitive to changes in demand.
However, we don’t normally have the sudden removal of a major energy producer (Russia) from global supply. All else equal, demand will need to slow more than normal to have a negative impact on energy prices given the production and refining capacity constraints. This same principle would apply to any supply constrained product. The chart above shows that new orders for both manufacturing (blue line) and services (red line) began to slow during the fall of 2021. However, input cost prices for both manufacturing and services (black and grey lines) have remained steady. Slowing demand hasn’t made much of a dent in prices yet for general manufacturing and services, according to the ISM survey.
Tracy Bell, CFA
Director of Equity Strategies
S&P 500 Index is regarded as a gauge of large cap U.S. equities. The index includes 500 leading companies and captures approximately 80% of the available market capitalization.
Presentation is prepared by First Horizon Advisors – May 17, 2022.
Sources:
1 Factset
2 Bureau of Labor Statistics
3 Bloomberg News
4 Energy Information Agency (EIA) Short Term Energy Outlook, May 10, 2022
