Corporate America is beginning to feel the pain from soaring prices, just as ordinary Americans have for the past year. For the most part, businesses have been able to pass on their higher costs to customers. That’s changing. A squeeze on margins is bringing a profits recession, as companies are forced to tighten their belts, just like the rest of us.
So says Nancy Lazar, the longtime top-rated economist who’s one of Barron’s 100 Most Influential Women in Finance and now leads Piper Sandler’s macroeconomics research team. Containing bloated costs means cutting payrolls, she says, and will help lead to a recession starting in the current quarter. That puts the longtime optimist on the economy and financial markets in an unfamiliar bearish crouch.
Companies were a big beneficiary of the stay-at-home bubble resulting from the Covid-19 pandemic, Lazar relates in a telephone interview. The trillions of dollars in federal largess for consumers ended up in corporations’ revenue streams, which they used to hire lots of workers to meet demand. Now that process is reversing.
Consumers’ real incomes have fallen amid soaring inflation, while their real net worth has taken a hit from the bear markets in stocks and bonds, she observes. At the same time, they’re spending down their savings. All of which means that companies won’t be able to sustain price increases.
The labor market will deteriorate very quickly, she predicts. New claims for unemployment insurance have been rising sharply, to an average of 236,000 in the last four weeks, one-third higher than the low hit in April. Employment figures in the Bureau of Labor Statistics’ household survey (from which the headline unemployment numbers are derived) and wages already are slowing.
“So the consumer is going to be in even worse shape going into the back half of the year, which will put even more pressure on companies to stop increasing prices, and eventually cut prices,” Lazar contends.
Some companies get it, starting with
(ticker: RH), formerly called Restoration Hardware and known for its palatial stores and thick, heavy catalogs with high prices. Back in March, its CEO was already “screaming bloody murder,” Lazar says, about the sharp drop in furniture sales.
Since then, even big technology names, such as
‘ (META) Facebook and
(GOOGL) Google, have been forced to address costs. Some companies have begun to warn that second-quarter earnings, just beginning to be reported, are vulnerable. Guidance for the third quarter and beyond is liable to be worse, Lazar adds.
Profits are in the early innings of a decline that potentially will be much worse than anticipated by Corporate America, she warns: “Inflation is going to come back and hit them over the head.” Consensus earnings-per-share estimates for the
S&P 500 index
center around $230 for 2022; she thinks her $215 forecast is too high.
After the dot-com bubble at the turn of the century, S&P 500 earnings dropped 40%. Investors face the prospect of another outsize decline, Lazar says, given the marked tightening of monetary and fiscal policies, plus the out-of-whack corporate cost structures caused by overhiring.
The Piper Sandler economist says her team’s estimates suggest that companies added about a million too many workers to support the now-deflating stay-at-home bubble. (My personal indication of that deflation was the sight of a jogger running on a beautiful, sunny day, wearing a tee shirt emblazoned with a
logo. Which means he wasn’t home taking an online spinning session.)
Even amid signs that Corporate America is trying to correct its overexuberance by paring payrolls and inventories, which is sure to have painful side effects, Lazar applauds the Fed’s intentions to remove economic slack, which will raise the unemployment rate. Her team from Ella expects joblessness to hit 5%, significantly above the most recent reading of 3.6%, to bring inflation back closer to the central bank’s annual target of 2%.
For their part, Federal Reserve officials optimistically see unemployment edging up to 4.1% by the end of 2024, while hoping that their favored inflation measure—the personal-consumption expenditures price index—will gently fall into the 2% range by the end of next year.
Unlike some commentators, Lazar expects the central bank to stay the course to wring out inflation, even in the face of rising unemployment. “The last thing we want is a Fed that doesn’t take this seriously,” she says. She’s convinced that Jerome Powell & Co. will prevent inflation from becoming ingrained in the economy, as it did in the 1970s.
In that case, she doesn’t look for a recovery from the recession she sees starting until the second half of 2023. “I’m not used to being bearish,” she says. “But coming out of it, I will be very bullish. The US economy is inherently healthy, but we have to take the medicine now, so we can have another elongated expansion, which I think we will have.”
The big question: Will policy makers have the fortitude to stay the course now for a better outcome later?
Write to Randall W. Forsyth at firstname.lastname@example.org