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CEO North America > Opinion > America Inc. margins are shrinking

America Inc. margins are shrinking

in Opinion
- America Inc. margins are shrinking
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Earnings of the biggest firms have declined in the second quarter.

America Inc. has enjoyed an extraordinarily good run since the country rebounded from the global financial crisis of 2008-09. The economy has grown, while inflation has been low and interest rates rock-bottom. Despite unemployment hovering below 5%, wage pressures have been modest.

President Donald Trump’s tax reform cut the corporate tax rate from 35% to 21%. This and his deregulatory efforts have freed up capital. Companies have used the windfall to buy back shares—reducing the amount of stock and superficially boosting earnings per share. The S&P 500, Dow Jones Industrial Average and Nasdaq Composite, three leading share indices, hit record highs on July 15th. All told, annualized corporate profits exceeded $2 trillion last quarter, nearly double the level a decade ago.

Today, however, the mood in boardrooms is less ebullient. The latest survey by the Business Roundtable, a conclave of bosses, put confidence higher than the historical average and well above the level which would signal a recession. But it has slipped. The National Federation of Independent Business observes a similar decline in optimism among bosses of small and medium-size enterprises. Nearly four-fifths of S&P 500 firms that have issued guidance on financial performance for the latest quarter have indicated that earnings per share will fall year on year.

Analysts’ forecasts reflect these sentiments. Profits in six out of eleven big industries may have declined from April to June compared with a year earlier. FactSet, a research firm, estimates an average drop of 2.8% for S&P 500 earnings, on top of a 0.3% dip the quarter before.

Three reasons for the darkening outlook are as follows:

  1. Despite his friendly encounter with China’s president, Xi Jinping, at a G20 summit in late June, Trump threatened this week to impose fresh tariffs on $325bn of Chinese imports. According to JP Morgan Chase, the new levies could tip the economy into a contraction.
  2. The second reason for falling profits—rising labour costs—is good for workers but worrying for firms and investors. David Kostin of Goldman Sachs, an investment bank, calculates that total compensation, which includes wages and all benefits, represents 13% of sales for a typical American firm. Wages and benefits are now rising at roughly 3% a year, up from 2% in 2018 and just 1% earlier in the business cycle.
  3. The earnings crunch has to do with technology companies. Patrick Palfrey of Credit Suisse, an investment bank, notes that the list of top ten contributors to the second quarter’s profit crunch includes representatives of Big Tech. Hardware and semiconductor goliaths such as Apple and Intel are facing a cyclical downturn in demand for their products. Trade spats exacerbate it. So too has Trump’s decision on national-security grounds to impose sanctions on Huawei, China’s tech champion, which has upended global supply chains. Some internet firms are sputtering. Netflix’s share price lost 12% in after-hours trading on July 17 when the streaming giant reported the first drop in American subscribers since 2011.

The quarterly financial results unveiled this week by several big banks bolster the case for cautious optimism. A boom in credit cards and mortgages pushed profits up at JPMorgan Chase, Citigroup, and Wells Fargo. This implies that, as Jamie Dimon, JP Morgan Chase CEO, also said, “the consumer in the United States is doing fine.”

This will be cold comfort to industrial firms and other business-facing companies whose margins are shrinking. Given the sheer length of America’s record economic expansion, however, it really is not that bad.

Tags: America IncCEOCEO Northammargins

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