US corporate earnings: On par

As we near the end of a much anticipated earnings season, with market participants looking for clues on how well corporate America is doing in the face of the recent US regional bank turmoil and concerns about a possible economic slowdown or recession, we thought it would be worth commenting on what we’ve learned about the recent quarterly results, and the implications that the latest round of corporate earnings may have for fixed income investors as we look ahead to the rest of the year.   

Thus far, with 92% of S&P 500 companies having reported, 78% have posted earnings that have beaten expectations, which is above the 10-year average of 73%. It is also the highest percentage of S&P 500 companies reporting a positive EPS surprise since the third quarter of 2021. It is worth noting that the above consensus results come on the back of tepid expectations given that analysts had slashed forecasts before the season kicked off. Despite the beat, earnings still posted negative year-over-year growth, falling by 3%, albeit better than the 7% drop expected at the beginning of the season following the recent downward revisions. While revenues remained positive with companies reporting top-line growth of roughly 4%, profitability appears to have suffered as sales growth outpaced earnings growth, suggesting a squeeze on corporate margins.     

Of particular interest to us was the quarterly performance of the US High Yield credit market, which we have found in the past has offered an early warning signal for weakening economic conditions. The results so far show resiliency in this part of the market. Over 50% of US High Yield issuers have reported EBITDA ahead of analysts expectations, compared to 14% of issuers that reported a miss. According to JP Morgan, over 80% of high yield issuers in their US universe have provided what they consider either positive or neutral guidance on a forward-looking basis. This compares to only 12% of issuers providing a negative outlook (and an additional 7% of companies which did not provide full-year estimates). Another interesting point we think worth noting is that while the outlook from HY technology companies is more pessimistic, with 41% of the sector reporting guidance below consensus, old economy forward guidance is stronger, with only a minority of companies in these sectors reporting a softer than expected outlook. In our view, this is an important consideration for fixed income investors given the higher weighting of technology in the equity market relative to the HY index.       

Adding to the latest round of corporate earnings in which the worst of analysts expectations failed to materialize, we note balance sheets remain in a solid position to weather headwinds. Entering the quarter, cash balances remained above historically average levels, leverage was hovering near the lowest level since 2012, and coverage metrics had increased to a record high. Moreover, we note the technical remains very strong given the relatively benign maturity wall through 2024 (lower refinancing needs) and a shrinking High Yield market following a record contraction last year, where the US HY market shrunk by $163bn, or approximately 11%. We also note that part of the aforementioned shrinkage is due to the fact that there have been more Rising Stars than Fallen Angels of late, another sign that credit quality is still in reasonable shape.

Whilst we certainly acknowledge the downside risks for corporate fundamentals that would most likely come with tighter credit conditions, still elevated inflationary pressures, and an overall challenging macroeconomic environment, we believe the latest round of corporate results give us reasons to be cautiously optimistic as fixed income investors. Where markets continue to fret over mounting economic uncertainty, the health of the US banking system, and now a looming US debt ceiling deadline, we are encouraged by the positive performance from corporations during the first quarter of the year. This, alongside the solid earnings from systemically important financial institutions , continue to tell us that the current position of corporate health is a strong one, and thus, should help avoid a pronounced spike in default rates and indeed support expectations that they remain in line with the long-term historical average - at or near 3% for FY 2023.