American companies are facing the biggest drop in profits since the shutdown of Covid

Corporate America faces the biggest drop in profits since the early stages of the coronavirus pandemic, according to Wall Street forecasts, as high inflation squeezes margins and fears of an impending recession dampen demand.

According to analyst estimates compiled by FactSet, the companies included in the S&P 500 index report a 6.8 percent decrease in earnings in the first quarter compared to the same period of the previous year. That would be the biggest drop since the more than 30 percent drop in the second quarter of 2020, when the rapid spread of Covid-19 led to a widespread economic shutdown.

Ahead of the first-quarter earnings season, which begins with three major banks reporting on Friday, sectors such as energy and consumer discretionary are expected to post strong annual profit growth. However, subdued consumer demand, tighter credit conditions and lower commodity prices have reduced earnings expectations in many industries.

“When you look at wage costs and capital costs, I think margins are under quite a bit of pressure,” said Jack Ablin, chief investment officer at Cresset Capital. “Companies enjoyed nominal growth, had some pricing power, but volume either shrank or remained unchanged.”

Bar Chart of Expected Earnings Per Share Growth (%) in Q1: S&P 500 Earnings Outlook Plunges

Wall Street analysts’ gloomy outlook belies a relatively buoyant market, with the S&P up more than 6 percent since the start of the year. Despite this, only 20 stocks accounted for nearly 90 percent of the increase. Falling interest rate expectations boosted the appeal of the biggest technology companies, a development that masked the weaker performance of the broader stock market.

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Analysts expressed higher expectations before the quarter, predicting a 0.3 percent decrease in profit by December 31. While earnings forecasts typically fall over the course of a quarter, they did more in the opening three months than the average over the past five years. Only the utility sector ended the quarter with higher expectations than it started.

More companies than usual signaled weakness in the first quarter, with 78 issuing negative guidance for their earnings per share — indicating management expects to miss analyst forecasts — 37 percent above the five-year average. The semiconductor industry, which is part of the broader information technology sector, issued 11 such warnings.

Of the 11 sectors in the S&P 500, materials are expected to fare the worst, with a 35.6 percent decline forecast.

“Typically, we see volatility in material prices and profits in anticipation of a recession,” said Brad McMillan, chief investment officer at Commonwealth Financial Network. “Companies hold back on cuts in anticipation of slower sales.”

Bar chart of the number of warnings in the first quarter, showing that the technology and industrials sectors led the group of profit warnings

New orders for durable goods in the United States fell for a second month in a row in February, while analysts had expected a pick-up in buying.

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As purchases of goods slow, an increase in spending on services is expected to make the consumer discretionary sector the best performer in the quarter with revenue growth of 34 percent, driven by a strengthening of hospitality-related industries. Profit growth in the airline industry is expected to make the industrial sector the second best at 12.6 percent.

Despite recent turmoil in the U.S. banking sector, the financial sector is expected to report a 2.4 percent increase in profits and lead all sectors with revenue growth of 9.1 percent, compared to an average of 1.8 percent. Citigroup, Wells Fargo and JPMorgan Chase will report first-quarter results on Friday, before the market opens.

“Because recent bank failures have occurred in the final weeks of the quarter, the full impact will not be reflected in the first-quarter reports,” Goldman Sachs analysts wrote in a note to clients.

However, according to Ablin, the bankruptcy of three banks this year could put pressure on small and medium-sized enterprises for the rest of 2023.

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Unlike large companies, which have “fairly unlimited access” to capital, “I think mid-sized and small companies are likely to be increasingly disadvantaged by the credit crunch,” he said.