Are Corporate Earnings at Risk in Q2?
Thu, Jun 11, 3:20 PM ET, by Scott V. Nystrom
The economy may or may not have bottomed, but don’t expect corporate earnings outside of the energy and commodity sectors to get a big lift in the second quarter of 2009.
Here’s why. Consumer spending and business investment are major drivers of economic growth and corporate earnings. These drivers are down and failed to turn the corner so far.
Households are Borrowing Less, Spending Less, and Saving More
More recently, consumer spending as a share of Gross Domestic Product (GDP) has fallen from a peak of 72 percent in 2007 to 70 percent in the first quarter of 2009.
Consumer borrowing dropped $15.7 billion in April from the previous month according to the Fed. The Fed also revised the March consumer borrowing decline to $16.6 billion—the largest absolute dollar decline ever recorded—from an earlier estimate of $11.1 billion. In percentage terms, consumer credit fell at an annual rate of 7.4 percent in April, following a 7.8 percent drop in March. The two monthly declines represented the largest percentage decline since an 8.1 percent drop in December 1990. Aggregate consumer borrowing is at $2.52 trillion in April.
An April Fed survey of bank-loan officers showed that demand for loans from households was down in almost every category. People borrow more when they feel confident about a growing economy. Housing prices are still falling in many major markets around the country. Until housing stabilizes and then begins to move up, consumer borrowing will likely remain low.
Households have been spending less and saving more in response to large declines in the value of their homes and retirement savings and rising joblessness. The unemployment rate hit 9.4 percent in May—a 25 year high—with employers cutting a net 345,000 jobs.
People fearful of losing their job are increasing savings. Personal saving was reported at 5.7 percent in April—a 14 year high. A rising trend of increased saving translates into less consumer spending.
Businesses Aren’t Investing
The Washington Post published a hopeful article on June 5th titled, “First Rumblings of New Investment,” reporting that United Airlines (UAUA) announced they are planning a major purchase of new jets over the next few years. Is this a “green shoot” on the business investment side?
Let’s look at the data.
Buried in the middle of the article it says, “In the first three months of the year, investment in commercial structures plummeted at a 36.9 percent annual rate and investment in equipment and software fell at a 33.5 percent rate, according to Commerce Department data. Spending on transportation equipment has been particularly hard hit; in the first quarter, it was 67 percent lower than at the beginning of 2007 and reached its lowest level since 1970, even when adjusted for inflation.”
One large airline making plans to buy jets does not constitute a trend reversal against the most dramatic downturn in business investment in four decades.
On the commercial loan side, the April Fed survey reported that 40 percent of senior loan officers are tightening their credit standards for commercial and industrial lending. More importantly, demand for business loans weakened with 60 percent reporting lower demand for commercial loans.
Factory orders for non-defense capital goods excluding aircraft fell 2.4 percent in April. This was overshadowed by last Wednesday’s report that overall factory orders were higher—up 0.7 percent in April—driven by a surge in durable goods orders (up 1.7 percent). Non-defense capital goods excluding aircraft are a leading indicator for business investment.
The Economy Isn’t Strengthening
The economy has already contracted more than 3 percent over the six month period from October 2008 through March 2009.
Signals from leading indicators suggest the economy is unlikely to gain strength in the second or even the third quarter of 2009.
As listed above, five major leading indicators of future economic growth signal economic decline:
1. Consumer borrowing (positively correlated);
2. Consumer spending (positively correlated);
3. Business loan demand (positively correlated);
4. Non-defense capital goods orders excluding aircraft (positively correlated); and,
5. Personal saving (inversely correlated).
Dallas Fed President Richard Fisher had it right when he commented in late May, "I would be delighted, but surprised, if meaningful sustained growth gets under way before the end of the year."
More Threats to Economic Recovery
There are additional forces likely to drag the economy down including:
· much higher oil and commodity prices since the beginning of the year;
· higher long Treasury rates, increasing the cost of business investment;
· rising mortgage interest rates, reducing demand for housing and all the related goods purchased by homebuyers;
· major numbers of job losses in the 2nd and 3rd quarters associated with bankruptcies at GM, Chrysler, and their suppliers;
· large new tax increases being proposed at the federal, state, and local levels; and,
· cap and trade legislation moving through the U.S. Congress, which would raise energy prices, businesses taxes, and consumer prices.
Conclusion—Downward Earnings Adjustments Ahead
Many publicly traded companies—with the exception of energy and commodity producers—are likely to reflect this continuing recessionary trend with lower earnings guidance over the next month.
Have you looked at the possibility of lower Q2 earnings for companies in your portfolio?
Disclosure: No positions.
SDI Glossary: "price" Definition
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SDI Glossary: "GDP" DefinitionThis Article's Word Cloud:
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