Four themes to follow as corporate profits surge
The quarterly earnings season is upon us once again, and analysts expect another batch of knockout earnings reports. Per-share profits at companies in the S&P 500 are forecast to have risen 20.8 percent in the second quarter compared with a year earlier, according to analyst estimates compiled by FactSet through last Friday. That would be the second straight quarter of 20-percent-plus jumps, something that hasn’t happened since late 2010. Here are some key themes to listen for. The Trade War
So far the Trump administration’s trade war hasn’t sunk the stock market, as many had predicted it would. Sure, there are pockets of trouble. Shares of the construction equipment company Caterpillar have struggled in part because the firm is considered doubly vulnerable to trade tensions; more than 50 percent of Caterpillar’s sales last year came from outside North America. The company is also a large consumer of steel, which has risen in price thanks, in part, to Trump administration tariffs on imports.
Still, the pain has been relatively limited so far and not everyone will see this as bad news. Shares of small companies, which tend to sell most of their products domestically, have done well.
But analysts and investors will be listening closely for any other indications that the expanding trade war is starting to delay plans for corporate spending. So far it hasn’t, executives say.
“It is not at this point causing them to change the strategic actions and decisions that they’re making,” Marianne Lake, chief financial officer for JPMorgan Chase, the country’s largest bank by assets, said on the bank’s post-earnings call earlier this month.
Investment
With the economic expansion in its ninth year — the second-longest stretch of growth on record — a burst of corporate investment will be a key to keeping the streak alive. Key provisions of the Trump administration’s tax overhaul were designed to provoke such a spending boom on new factories and equipment.
In the first quarter, there was a solid uptick in business investment, though whether it’s because of the tax bill or unrelated developments — such as the rebound in oil and gas prices — is a matter of some debate.
These long-term, big-ticket investments — known as capital expenditures, or “capex” — don’t just mean executives are feeling flush. Because they might take years to yield profits, they also require significant confidence in the economy over the long term, so they are a good clue to where executives think things are heading. It is not clear that companies are rushing to make these kind of investments in plants and equipment.
“We are not yet seeing what I would call a lot of traditional CapEx spending occurring,” Curtis Farmer, president of the midsize lender Comerica, told analysts on a conference call last Tuesday.
Buybacks
When companies have cash to spend but are not willing to commit to big investments, they often instead buy up their own stock. A surge of buybacks, another byproduct of the tax-bill windfall, helped shore up the stock market earlier this year. When companies buy back shares, they cut the number of shares outstanding, raising earnings per share. The case for a buyback is that this can help push a stock price higher and a big buyback announcement tends to be applauded by stock investors.
Shares of Warren Buffett’s Berkshire Hathaway jumped about 5 percent last week, after the company said it removed a limit on share repurchases.
Buybacks have their critics too, who deride them as financial engineering that only benefits shareholders in the short run. Spending that money on new equipment or a factory might create jobs for the workers who will build a factory, say, and those who will be employed in it, and add to profits over the long term.
Wages
Wage growth is a key factor in the U.S. economy, as consumer spending accounts for roughly two-thirds of gross domestic product. At the same time, for investors, wage growth isn’t always positive. Rising labor costs can cut into profits, muting the impact of a robust economy. In some sectors, that seems to be happening.
Trucking firm J.B. Hunt Transport Services reported better-than-expected profits last week only to see shares slide after it cited “driver pay and retention costs” and “driver recruiting costs” as some of the outlays that nibbled away at the benefits of higher prices and booming volumes.