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The US corporate earnings season is almost over, and it has been a good one. And that could be bad news.
Let us start with what is good about it. First, the earnings themselves look healthy: up 9.6 per cent for the fourth quarter of 2013 compared to the same period of 2012, according to Thomson Reuters. For the year as a whole, earnings are on course to rise by 6.1 per cent. All this is despite significant drag from the energy sector, where earnings dropped almost 5 per cent in 2013.
Second, CFOs have played their regular quarterly game with brokers' analysts with more skill than usual. Some 69 per cent produced results that exceeded brokers' consensus forecasts, according to Thomson Reuters. They also caught analysts by surprise with their revenues, with 64 per cent of companies exceeding expectations.
According to BofA Merrill Lynch, this is the best performance for revenues, compared to expectation, in two-and-a-half years. With fears that the world economy is growing rather slower than had been hoped, this can only be encouraging.
Third, the prognosis for the future also looks decent. US CEOs have been using earnings calls – as tracked by Goldman Sachs' David Kostin for his quarterly "Beige Book" of S&P 500 executives' intentions – to prepare their investors for more capital expenditure, which can only be healthy for the global economy. They also seem keen to disburse more of their cash. That will please their investors. It also suggests an end of the extreme lack of confidence, which saw many companies maintain inefficient balance sheets rather than go without a cash buffer.
Why might all of this be bad news? Despite these apparently excellent results, the stock market still endured its worst start to a year in the post-crisis era. CFOs may have successfully pushed the expectations bar low enough for them to jump over it, but it did them little good.
The short-term bonus for companies that "beat" their expectations was less than usual. Five days after their announcement, Merrill Lynch's Savita Subramanian found that they had, on average, beaten the S&P by 2.1 percentage points. The punishment for missing expectations was unusually severe, with an underperformance of 5.5 percentage points. Put these together, and the gap between the earnings season's "winners" and "losers" was its widest since the fourth quarter of 2008 – when the financial crisis threatened calamity.
As Ned Davis Research's Ed Clissold put it: "Beating estimates has not helped much, but it has been better than missing." In short, earnings season confirmed that last year's stock market rally had taken a lot on trust. Investors plainly expected better.
A broader geographical perspective also gives cause for concern, in Europe. Europe's earnings season is revealing a continent that is still sickly and at risk of deflation. Revenues of the 122 Stoxx 600 companies to have reported so far were slightly lower – by 0.8 per cent – in the fourth quarter of 2013 than they were a year earlier, according to Thomson Reuters.
From these weak revenues, Corporate Europe extracted far lower profit margins, which for non-financial companies have now dropped back almost to their low levels of 2009. Put poor revenues together with poor margins, and Société Générale's Andrew Lapthorne shows that Europe's share of the earnings generated by the MSCI World index (which covers the developed world) has dropped to its lowest level since 1985.
This might be read as positioning the continent ideally for a cyclical comeback. But it does show that the large flows of money from the US to Europe over the last months have taken an awful lot of trust. Corporate Europe has not yet done anything to justify that trust. A period of economic stagnation, increasingly feared, would make this look all the worse.
A final reason concern comes from what US CEOs have been telling investors about their future. They are confident in growth, particularly from emerging markets, enough to spend and disburse more cash. But they still feel it necessary to caution that it will be harder for them to expand their margins.
Goldman's research found a range of companies in different sectors making the same points, that cost increases and competition would put a squeeze on profit margins. Companies such as McDonald's (MCD) and Nike (NKE) complained of cost increases – names from Ford Motor (F) through Johnson & Johnson (JNJ) to Schlumberger alerted on competitive pricing.
Margins in the US look unhealthily high. If improving economic conditions and normalising monetary policy make life tougher for the corporate sector, that can be viewed at least as a healthy normalisation. But it would be easier to take that view if stock markets had not taken quite so much on trust last year.
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