• Tuesday, February 27, 2024
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Tech crunch could herald US ‘earnings recession’

Tech crunch could herald US ‘earnings recession’

Equity investors are bracing for a second successive drop in US quarterly profits, led by the technology and materials sectors, that could undermine a record-breaking run in the stock market.

Blue-chip companies across America are expected to reveal a 2.8 per cent drop in earnings per share for April to June, following a first-quarter contraction of 0.3 per cent, according to FactSet data. If this happens, the two back-to-back quarters of shrinking earnings would constitute an “earnings recession” — a phenomenon equity investors have not witnessed since mid-2016.

Contracting corporate earnings would underscore concerns over US economic growth, coinciding with the trade dispute with China and recent disappointing manufacturing data. The end of the decade-long US expansion could prompt investors to reduce risk by shifting assets into bonds to weather a downturn.

Despite the first-quarter earnings contraction, US shares have continued to soar. Last week the S&P 500 index of US companies touched 3,000 points after comments from Federal Reserve chair Jay Powell reinforced the market’s view that the central bank will clip interest rates later this month.

Technology stocks appear particularly vulnerable to a drop in earnings. Analysts estimate earnings per share at tech companies will shrink by just over 7 per cent on average compared to the second quarter last year, tying with materials as the worst sector by earnings growth forecasts, according to Credit Suisse.

The tech sector — which, after an index reshuffle, no longer includes social media groups such as Facebook and Google’s parent company Alphabet and is instead dominated by hardware companies — is suffering a squeeze on its profits due to a tightening labour market, according to Goldman Sachs. Labour costs amount to about 16 per cent of revenues for the information technology companies, the second highest level after the industrials sector, according to the bank.

“The margin pressure for large tech companies is what is driving the drop in earnings,” said Patrick Palfrey, senior equity strategist for Credit Suisse. “There is earning pressure but it’s not universal — it’s being felt among a few companies, but they happen to be very large.”

Not all analysts are convinced earnings will fall. US companies typically offer dire guidance to prompt analysts to lower earnings predictions — creating a low bar that is easy to surpass when results are officially released. This occurred in the first quarter, when predictions of a 4.6 per cent drop in earnings based on company guidance eventually became a 0.3 per cent drop.

The impact of share buybacks will also soften the impact of lower earnings on a per share basis. Company stock repurchases remove shares from the market, so earnings are spread across fewer shares. First quarter stock buybacks for S&P 500 companies hit $205bn and if the pace continued in the second quarter, companies will be on course to surpass last year’s record $806bn.

Weaker corporate earnings comes as disappointing economic data signal a cooling US economy, said Mr Palfrey of Credit Suisse. “We don’t see a recession coming in the next few years but we are cautious,” he said.