America’s biggest companies, the constituents of the S&P 500 index, have just produced a second successive quarter of double-digit profit growth for the first time since 2011. Earnings rose by 12% year-on-year in the April to June period, compared with 15% in the first quarter. Robust sales, a weaker dollar – around half the S&P 500’s sales are made overseas – and further cost-cutting have all helped. This has buoyed sentiment on Wall Street, which had been reeling from the glaring absence of the Trump administration’s widely trumpeted stimulus. Investors “overestimated Trump but underestimated earnings”, Christopher Probyn of State Street Global Advisors told The Wall Street Journal.
But while this marks an impressive comeback from the profits recession of 2015-2016, “it’s hard to be optimistic about where profits are heading”, says Justin Lahart, also in The Wall Street Journal. If wage growth doesn’t take off soon, US consumers, who have been depleting their savings to finance expenditure, won’t be able to buy so many of their products, implying weaker sales growth.
The alternative, however, is for employers, responding to the tightening labour market, to start paying their staff more. But that means a squeeze on their margins, reducing profit growth too. Firms could offset the higher labour costs to some extent if they had invested in new plants and equipment over the past few years to beef up productivity. Unfortunately, in uncertain times, “companies’ knee-jerk tendency is to go into cost-cutting mode rather then buy equipment that might boost efficiency in the future”. Expect the momentum behind US earnings growth to fade.