US companies are going to find it much tougher to pass on inflation to consumers, Goldman Sachs says
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- US companies will find it much harder to pass on price rises to consumers, Goldman Sachs said.
- Sharon Bell, a European stock strategist, said profitability is still high, but it's going to get squeezed.
- A strong dollar and inflation have already hit the likes of Tesla, Netflix and Microsoft.
So far, Corporate America has weathered inflation at 41-year highs without suffering too many ill effects on profitability.
But US companies are going to find it increasingly difficult to pass on price increases to consumers, and as a result, earnings estimates still look far too optimistic, according to Goldman Sachs.
Goldman strategist Sharon Bell on Thursday underlined the bank's view that the bear market in stocks is not over yet — not least because company margins, and by extension earnings estimates, are still too high.
"Most CEOs are still seeing very high input-cost inflation, very high raw material-cost inflation," Bell told CNBC. "Really, whether you see it come through to consumer price inflation depends on how much they pass through."
"The last couple of quarters, companies have passed through most of it. Because employment has been strong, the economy has been strong, consumers have had savings — so they've been able to pass through most of that to the consumer," the senior European equity strategist said.
"I think it will become more difficult to pass that through to the consumer, and we are expecting margins to be squeezed," she added.
Companies from across the US corporate spectrum — from luxury electric carmaker Tesla, to pizza delivery company Domino's, to social media app maker Snap — have cited the impact of inflation on their bottom lines, in earnings reports on the three months to June.
According to Zach's Research, 72.9% of companies have beaten earnings-per-share estimates in the second quarter so far. But this is the lowest percentage since the first quarter of 2020 for the group of 48 companies Zach's tracks, and the third lowest in the preceding 20 quarters.
In a note earlier this week, Bell and her team pointed out that in the past eight recessions since 1970, there has been an average decline of 14% in earnings-per-share estimates in the US and a far more aggressive decline of 20-30% in Europe.
"When I speak to most of my clients — fund managers, etc. — they're very skeptical about the bottom-up earnings forecasts. Now, I do think they reflect a little bit of what we've seen in the first half of the year, so they're a little bit trailing," Bell said.
Economic growth and employment held up robustly in the first half of 2022, even as inflation was picking up to its highest since the early 1980s. That rise came amid surging energy and raw material prices, stemming in part from Russia's war in Ukraine and from general disruption in trade flows in the wake of the pandemic.
As the Federal Reserve has raised interest rates in response to that rise in consumer prices, borrowing costs have grown and the dollar has strengthened. That has undermined foreign revenues for several big names, including Netflix, IBM, Johnson & Johnson and Microsoft, in these most recent quarterly results.
The dollar has risen to its highest in 20 years against a basket of major currencies, meaning the value of revenue from key markets like Europe, India, Japan or Mexico has fallen. A recent analysis from Bloomberg showed references to "foreign exchange" in earnings calls hit the highest in three years.
"Inflation has been high and it is quite good for companies — at least initially — because that means they're passing on some of these additional prices. But I think more medium-term, these earnings estimates are going to come down," Bell said.
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