Hot inflation slows 3Q earnings growth forecasts

Wall Street expects the latest round of quarterly profits to show burn marks from the hottest inflation in four decades, and the damage could linger into 2023.

Analysts have been trimming their forecasts, especially in the retail and communications sectors, as inflation drives up costs and saps consumer spending on everything from food to clothing. Companies within the broad S&P 500 index are expected to notch earnings growth of roughly 2.6%, down from June projections of 9.5% growth. That would be the S&P’s slowest growth since the third quarter of 2020, according to an analysis from FactSet.

The technology sector is now expected to have contracted in the third quarter – a sharp revision from expected growth previously. Appliance maker Whirlpool, retail giant Target and many other companies could report even sharper declines in profits than anticipated months ago.

Other sectors have boomed in spite of inflation. Makers of household necessities managed to shore up or even increase profit margins by raising prices through the economic recovery as inflation heated up. Some even thrived on inflation to increase profits. Real estate investment trusts have maintained their generous profit growth forecasts since June. Forecasts have increased for energy companies because of high energy prices that have only recently started to ease.

Earnings growth for most companies remains precarious, though.

“The path of least resistance for the remainder of this year is still down,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “Most things are going against any kind of stabilization in earnings from these levels.”

Inflation has shown few signs of abating, although gasoline prices have fallen from historic highs.

Halting inflation could hurt certain industries. The Federal Reserve has aggressively raised interest rates to make borrowing more difficult and generally slow economic growth. The rate hikes have propelled mortgage rates higher, making the market even more difficult for homebuyers.

The U.S. dollar has strengthened significantly against other currencies and that cuts into their foreign earnings. Labor costs are also rising. Higher prices are becoming too burdensome for some consumers and prompting a drop in demand.

“It is just a matter of time before profit growth becomes the next risk for investors,” said John Lynch, chief investment officer for Comerica Wealth Management.

Profits will likely be flat for the broader S&P 500 in 2023 if the Fed can tame inflation without slowing the economy too much, Lynch said. But a broad drop in profits is possible if the economy slips into a difficult recession.