The Economist July 17th 2021 Finance & economics 65I
t ismid-july,sothefootballseasonin
England will start soon. You probably
hadn’t noticed it had ended. The earn
ings season, when listed companies in
America reveal their quarterly results,
comes round with similarly tedious
frequency and also never seems to stop.
The secondquarter season that kicks off
this week ought to stand out, though.
Public companies in aggregate are ex
pected to reveal the largest increase in
profits since the bounceback from the
Great Recession of 200809.
Optimism about earnings has driven
share prices higher in the past year. But
financial markets are relentlessly for
wardlooking. And with bumper earn
ings already in the bag, they now have
less to look forward to. A rally in bond
prices since March and a selloff in some
cyclical stocks point to concerns about
slower gdpgrowth. A plausible case can
be made that the earnings outlook might
worsen as quickly as it improved.
Start with the bottomup forecasts for
profits by company analysts. They expect
earnings per share for the msciworld
index of stocks to rise by 40% in 2021,
according to FactSet, a data provider.
That is a good deal higher than at the
start of the year, when the forecast was
around 25%. A slowdown to a growth rate
of 10% is expected in 2022. Then again
forecasts tend to start out at 10%, a nice
round number, before being revised
upwards (as in, say, 2017) or downwards
(as in 2019) as news comes in.
Profits swing around a lot. For big
businesses, a lot of costs are either fixed
or do not vary much with production.
Firms could in principle fire workers in a
recession and hire them back in a boom
so that costs go up and down with rev
enues. But this is not a great way to run a
business. A consequence of a mostlystablecostbaseisthat, when sales rise or
fall, profits rise and fall by a lot more. This
“operating leverage” is especially powerful
for companies in cyclical businesses, such
as oil, mining and heavy industry. Indeed,
changes in earnings forecasts are largely
driven by cyclical stocks.
If global gdpgrowth falls, then profits
will fall faster. There is already some
evidence of a slowdown. The output and
orders readings in the global manufactur
ing purchasing managers’ index (pmi), a
closely watched marker of activity, fell in
June. Global retail sales surged in March,
but have gone sideways since. The evident
slowdown in China’s economy may be a
portent, writes Michael Hartnett of Bank
of America. China emerged from lock
down sooner; its pmipeaked earlier; and
its bond yields started falling four months
before Treasury yields did.
Slower economic growth is one part of
a classic profit squeeze. The other is rising
costs. A variety of bottlenecks have
pushed up the prices of key inputs, such as
semiconductors. Too much is made of
this, says Robert Buckland of Citigroup, abank. Input prices typically go up a lot in
the early stages of a global recovery. Big
listed companies usually absorb them
without much damage to profits. Rapid
sales growth trumps the inputcost
effect. The real swing factor is wages,
which are the bulk of firms’ costs. The
recovery is barely a year old, but there is
already evidence of a tight labour market.
In America the ratio of vacancies to
new hires, a measure of the difficulty
firms have in filling jobs, reached a re
cord in May. Businesses that were forced
to close during lockdowns have lost
some workers to other industries. Others
are dropping out of the labour force
altogether. Thanks to the recent surge in
the prices of assets, including homes,
some people are choosing to retire early,
says Michael Wilson of Morgan Stanley.
An obvious remedy for rising costs
would be to raise prices. Though in
flation is surging in America, that re
flects price rises for a small number of
items. Many businesses tend not to raise
prices straight away. They are mindful of
losing customers to rivals who don’t
raise prices. And there are administrative
costs to changing prices frequently. A
study published in 2008 by Emi Naka
mura and Jon Steinsson, two academics,
found that the median duration of prices
is between eight and 11 months. Prices of
food and petrol change monthly but
those of a lot of services only change
once a year.
A profits squeeze is not certain. Any
number of influences could give fresh
impetus to global gdpgrowth: a bumper
infrastructure bill in America; more
policy stimulus in China; or some con
crete signs that supply bottlenecks are
easing. Still, while the earnings season
now under way ought to be a sunny one,
margins look vulnerable. Buttonwood Margin call
Why investors are anxious about a profits squeeze in 2022circumstances and higher import prices.
The new allocation will give governments
more room to use their hardcurrency re
serves to import food or vaccines.
Yet the huge headline figure sounds
more generous than it really is. The new
sdrs will be distributed broadly in propor
tion to the funding countries provide to
the imf—meaning that the rich world will
receive more than half the allotment. Low
income countries will receive a mere 3.2%
of the total, equivalent to $21bn, or roughly
4% of their combined output before the
pandemic. That does not seem enough,
considering that these places face new
variants without ample vaccines and can
not borrow as easily as richer ones.
In order to redress the imbalance be
tween allocation and need, rich countries
with little use for more reserves are work
ing out ways to donate some of their new
sdrs. Contributions of about $15bn in ex
isting sdrholdings have already helped
expand an imffacility offering nointerest
loans to poor countries over the past year.
A larger facility, funded by sdrdonations
of as much as $100bn, may be announced
in August. This is intended to boost poorcountries’ health systems, support eco
nomic recovery and help them prepare for
climate change.
The financial contortions behind sdrs
invite criticism. Republicans in America’s
Congress, for instance, fret that the alloca
tion offers little help to poor nations while
giving a windfall to rivals like China and
Russia. In fact such places are unlikely to
make much use of their sdrs. More target
ed aid would probably face political hur
dles of its own. A roundabout, opaque
means of support may not be ideal;butit is
probably the best the fund can do.n