It’s been a buoyant earnings season, with many companies improving their profit margins and taking rising input costs in their stride. But can it last?
- Companies have been able to raise prices ahead of input costs, with little decline in volume growth.
- Many are forecasting further price rises in the year ahead, even as input costs are moderating.
- It leaves share prices quite high at a time when economic risks are mounting.
The most recent earnings season has been encouraging. While many fund managers were gloomily awaiting sliding profit margins as higher input costs and weaker economic activity started to bite, the reality has been the opposite. Companies have improved their profit margins, justifying – to some extent – the relative optimism of stock markets since the start of the year.
The secret sauce has been pricing power. Companies have been able to raise prices ahead of input costs, with little decline in volume growth. This is particularly true among the consumer staples giants – Unilever, Coca-Cola, Diageo – who have all managed to raise their prices by 8-12%. Many are forecasting further price rises in the year ahead, even as input costs are moderating.
This hasn’t necessarily gone down well with consumers. ‘Greedflation’ has become the new buzzword, with companies accused of profiteering at the expense of the cash-strapped public. The ECB GDP Deflator shows that in the last two quarters of 2022, profits accounted for a greater chunk of the rise in prices than wages. This was less pronounced in the UK.
Others would argue that it is self-limiting. Eventually people will run out of cash. No sensible consumer spends a disproportionate amount of their household income on, say, Marmite or Heineken. Eventually, they will cut back, make substitutions and volume growth will fall, forcing companies to moderate price rises.
However, markets don’t care terribly much about a year or two in the future. For the time being, they see companies improving their profit margins and believe their current share prices are justified. The party can continue for a little while longer.
It does leave share prices quite high at a time when economic risks are mounting. The S&P 500 is now around 6% higher than its level a year ago. During that time, there has been a vast increase in interest rates, significant geopolitical tensions and now the looming problem of the debt ceiling. It’s not as if share prices were particularly cheap before, at least in the US.
While the strong earnings season has been a source of some relief among fund managers, there is still plenty of caution around. It may have lulled markets into believing that the risks associated with inflation higher rates and weakening economic activity have evaporated. They haven’t. The party can only go on so long.
