Are US corporate earnings set to tumble?

The reporting season for Q3 is getting underway with some bellwether companies releasing their results. Friday is a big day with JPMorgan, Citi and Morgan Stanley all reporting. What are their plans for loan loss reserves? Have they had any more ‘accidents’ as a result of tightening financial conditions?

We also have Pepsico, Domino’s Pizza and Delta. The day before we hear from TSMC with concerns about the shortage of semiconductors turning into a glut, plus further actions by the US government to restrict China’s access to advanced technology.

I wouldn’t be surprised if it’s a successful reporting season but analysts will be looking beyond the headline numbers. It’s the outlook for earnings that’s most worrying with a significant decline in margins in prospect.

Let me explain why. First and foremost, inflation is too high and the Federal Reserve need to slow the economy to get it down. This will almost certainly involve a recession. Margins always fall in a recession. Moreover, margins are near record highs and even without an economic slowdown would tend to revert towards the historic average.

US capital expenditure has been booming and while this is to be welcomed for the long-term health of the US economy, the associated increase in supply depresses margins. In addition, the labour market is drum tight and that means workers can claw back some of the income share they have given away to profits. The strong dollar and economic travails overseas will also eat into earnings.

Against this background, equities look set to struggle. I don’t think the outlook is disastrous. After all, markets have already fallen a long way. Investors are pessimistic. There are good reasons for expecting the upcoming US recession to be shallow and brief. If I’m right, it would represent a great buying opportunity. But the outlook for the next few months is for further weakness, in my personal view.

I haven’t mentioned the UK at all his week, for a change, but I’ll be giving lots of detail on this and other issues at our annual conference in London. Please speak to your contact at Columbia Threadneedle Investments for more information.