Written by Invesco Chief Global Market Strategist Kristina Hooper.
Fears have been brewing for some time. In early September, three US companies – two paint and coating companies and a homebuilder – provided earnings warnings because of supply chain issues.
- One of the paint companies lowered its sales guidance, citing lack of availability of raw materials for preventing it from meeting demand for its paint. (In fairness, one of the reasons cited for the scarcity of raw materials was Hurricane Ida, which exacerbated supply chain issues.)
- The second paint company also warned that supply-chain issues are impacting its sales volumes and suggested it was increasing prices to compensate for the rise in raw material prices. I think it’s important to stress that the company remains very positive, sharing that demand remains “robust” and “strong” sales are expected into 2022.
- Finally, the homebuilder also warned that supply chain issues have worsened in the back half of 2021 and that supply shortages have slowed its ability to complete the building of its homes, creating backlogs.
Since then, several other major companies have also warned about rising costs related to supply chain disruptions.
What are S&P 500 companies telling us about earnings?
But these warnings don’t mean that earnings season for the third quarter will be a disappointment. After all, companies have become very adept at managing expectations in advance of earnings reports, and generally we haven’t heard real alarm and substantial guidance downward. At this point in time, 103 companies in the S&P 500 Index have issued earnings guidance for the third quarter, with 54% (56 out of 103) providing positive guidance. This is well above the five-year average of 39%.
Certainly, many companies have been impacted by supply chain disruptions, rising input costs and rising labor costs – but it’s a question of how much they’ve been impacted and if they’ve been able to pass on the increase in costs. We can certainly glean some insights from the small number of S&P 500 companies – 21 to be exact – that have reported earnings thus far. So far, 16 out of those 21 companies have reported a positive earnings per share surprise and 15 have reported a positive revenue surprise, even though many are facing headwinds from the factors we discussed. On the third-quarter earnings calls that have occurred thus far, supply chain disruptions have been mentioned most often (15 of 21 companies reporting), with labor shortages and costs a close second (14 of 21). Companies also mentioned COVID costs and impacts (11 of 21) as well as transportation and freight costs (11 of 21).
European companies are facing similar challenges. No matter where companies are, they are likely experiencing supply chain disruptions, higher input costs and some issues sourcing labor.
Which sectors may be especially impacted?
However, some companies will be far more impacted than others. As my colleague Paul Jackson has pointed out, if all other factors are equal, a rise in cost will generally have the greatest impact on low-margin companies, which tend to be found in sectors such as transportation, general retail, construction and autos. Companies that should be least impacted are those with wide profit margins, limited raw material costs and small workforces. That should include growth sectors such as tech and health care. Unfortunately, those sectors’ stock prices may temporarily suffer as bond yields rise. Financials may be the standouts in this environment, especially as these companies would welcome higher yields. Another differentiating factor may be how much investment companies have made in technology to increase productivity.
When will these factors be resolved?
Some of these factors will be worked out sooner than others. Despite a lackluster jobs report for the month of September (which was due in part to a large loss in public sector jobs, especially in education), I continue to believe the labor market will normalize to a certain degree as some obstacles to returning to the workforce dissipate.
When it comes to the shortage of semiconductors in particular, that situation appears likely to improve soon, with projections for a return to normal levels of production by the second quarter of 2022. However, more general supply chain disruptions are likely to continue in the shorter term, especially if there are additional COVID waves, but the situation should improve as vaccinations and COVID immunity become more widespread.
In general, supply chain disruptions and higher input costs seem likely to be relatively transitory. Labor costs are a different matter and will vary by industry, with higher wages in the services sector most likely to become transitory because of high employee turnover.
And so, for me, I’ll be paying close attention to this quarter’s earnings season, but I’ll be most concerned about companies’ guidance for the fourth quarter and beyond -- especially how long they expect these conditions to last. What seems clear is that some industries will be impacted more than others, and some companies more than others. All in all, this situation suggests to me that investors need to be selective and discerning, especially if these factors are expected to last an extended period of time, and that active management matters in this environment.
