3 Reasons Why Company Earnings Have Been Weak

13 June 2016, 14:19
Sherif Hasan

The trend of weakness in corporate earnings is likely to continue in 2016. The most recent corporate earnings report from the Bureau of Economic Analysis for the first quarter showed after-tax profits down 3.6% from the first quarter of 2015. A negative 3.6% comparable growth rate puts the economy on track for lower earnings growth in 2016, which could potentially lead to an even slower year than 2015. In 2015, corporate earnings growth was 3.3%; in 2014, earnings growth was 0.1%.

A few factors have been significant across the board, while sector-specific risks are also occurring. The main macro trends include weaker global revenue from a strengthening dollar, slowed growth specifically in goods over services, and lower oil prices.

Strengthened Dollar

The dollar has been strengthening globally, which leads to a decrease in corporate profits for American companies. When looking at May 2016 exchange rates, you can see the effects from a strengthened dollar inflated against other currencies. For example, the dollar receives 1.30 Canadian dollars, 18.46 Mexican pesos, 110.27 Japanese yen and 0.9 euros in the current trading environment. Given competitive global pricing, translating this to dollars for corporate earnings thus results in lower revenue.

Additionally, an expected rate increase from the U.S. Federal Reserve, which is likely to occur in the second half of the year, could strengthen the dollar further. A rate increase would draw more foreign investment, increasing demand for the dollar and strengthening it against other currencies.

Goods and Services

The breakdown of goods versus services in the industry has also been a factor for corporate profits. Goods-producing companies grew production by a slow 0.4% in the first quarter of 2016, while services gained 2.6%. The goods sector continues to be a weak spot for the economy, with the 0.4% growth rate down significantly from the fourth quarter's 1.6% and the third quarter's 5%. Within the goods sector, durable goods were reportedly down the most, with a growth rate of negative 1.2% for the first quarter of 2016, down from 3.8% in the fourth quarter of 2016 and 6.6% in the third quarter of 2016.

Energy Prices

Energy prices are also a significant factor affecting corporate earnings. With oil prices low at nearly $50 a barrel for West Texas Intermediate crude oil, the sector overall has significantly been reporting losses, and there are few signs of relief in the second half of the year. The lost revenue from lower oil prices has caused a major decline in revenue for energy companies and has been a factor filtrating through other sectors as well. As a result, commodity-producing companies are reporting lower revenue. Industrial companies, with slowed manufacturing of durable goods for the sector, have also been reporting lower earnings. These energy sector factors have caused widespread weakening in corporate earnings for U.S. companies.

Overall, corporate earnings growth has been trending lower, with no significant signs of a rebound in the near term. The slowed growth in goods-producing companies continues to be a focus, as durable goods trend lower and services remain flat. Energy prices, while showing some small signs of recent improvement, are still projected to remain flat at their current low levels, which has a broadly negative effect on corporate earnings overall. Meanwhile, a rate increase expected for the second half of the year is likely to strengthen the U.S. dollar even further. The strengthened dollar has been the main factor, causing lower corporate earnings growth as inflated dollar values abroad translate to lower domestic earnings. An additional increase from the Federal Reserve is likely to cause further strengthening, which also keeps the near-term corporate outlook weak.

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