Corporate Health: Resilience in the Face of Higher Costs

The results of our latest survey of Loomis Sayles credit analysts, known as the CANDIs, reveal a complex but encouraging backdrop for corporate health. While input costs have been rising sharply, most key corporate fundamentals remain on solid footing. In our view, this combination reflects noteworthy corporate resilience as companies grapple with late-cycle challenges and tariff uncertainty.

Rising costs, tempered impact

One of the most striking findings from the latest reading is the broad rise in input and supply chain costs across industries. Credit analysts overwhelmingly expect increasing cost pressures across sectors. Expectations for tariff rollouts and labor shortages are key drivers of this trend, compounded by ongoing supply chain disruptions in some industries.

These pressures are not, in our view, derailing the broader fundamental backdrop. So long as a highly disruptive tariff environment can be avoided—though uncertainty around potential announcements and negotiations is likely to persist—we see potential for some input and supply chain costs to moderate. This view reflects both strategic adaptability at the company level and the continued strength of the US economy as it progresses through the late-stage expansion phase of the credit cycle.

Chart source: Loomis Sayles Credit Analyst Diffusion Indices, as of 31 December 2024. For the profit margins component, readings above 50 indicate a rising trend. 
The chart presented above is shown for illustrative purposes only. Some or all of the information on this chart may be dated, and, therefore, should not be the basis to purchase or sell any securities. The information is not intended to represent any actual portfolio. Information obtained from outside sources is believed to be correct, but Loomis Sayles cannot guarantee its accuracy. This material cannot be copied, reproduced or redistributed without authorization.

Profit margins show resilience

One might expect rising costs to hit profitability, but this quarter’s CANDIs results suggest a more nuanced story. Across industries, profit margins have remained stable, though our analysts do not expect significant expansion. For investment grade and large-cap companies, margins are near all-time highs. We believe stability at this level is a reassuring signal.

Chart Source: Bloomberg, as of 31 December 2024.
Used with permission from Bloomberg. The chart presented above is shown for illustrative purposes only. Some or all of the information on this chart may be dated, and, therefore, should not be the basis to purchase or sell any securities. The information is not intended to represent any actual portfolio. Information obtained from outside sources is believed to be correct, but Loomis Sayles cannot guarantee its accuracy. This material cannot be copied, reproduced or redistributed without authorization. Indices are unmanaged and do not incur fees. It is not possible to invest directly in an index. Past performance is no guarantee of future results.

Some sectors—US banks, for example—are showing signs of margin improvement. Strong demand for services like investment banking and recovering net interest margins, which troughed in mid-2024, have positioned banks for potential margin expansion, in our view.

On the other hand, industries reliant on discretionary consumer spending, namely retail, are likely to face ongoing challenges. Although consumer spending appears solid on the surface—driven by more affluent spenders who have benefited from consecutive double-digit annual gains in the S&P 500 Index—we expect expanded promotional activities, elevated freight costs and potential tariffs to weigh on profitability in the sector.

In our view, tariffs remain the most significant risk to margins across industries. Furthermore, we believe achieving meaningful margin expansion from here will be challenging given the already elevated levels of corporate profitability.

Diverging sector performance

While manufacturing is exhibiting some strength, services sectors face more pronounced challenges in the current environment. Below is a high-level look at some key takeaways from our sector analysts:

• Autos: The auto sector remains under pressure, grappling with potential tariff impacts and rising labor costs. Challenges in passing these costs through to consumers could weigh on profitability in the coming quarters, in our view.
• Homebuilding: Homebuilders have been supported by strong demand and supply constraints. Their ability to offer concessions, such as mortgage rate buy-downs, has provided a cushion against rising costs.
• Technology: We think AI infrastructure demand remains a key tailwind, supporting growth and profitability. We are monitoring potential tariff implementation very closely, especially on countries that manufacture tech hardware and equipment for US companies.      
• Energy: Long a laggard, we believe the energy sector could see upward revisions by mid-year, particularly if crude oil prices remain stable or rise.
• Gaming: The outlook is stable overall, though mobile gaming poses a risk to brick-and-mortar casinos. The continued recovery in Macau is a bright spot and may provide incremental growth opportunities, in our view.

We believe market volatility can offer opportunity

For investors, the combination of more broad-based earnings growth, steady corporate health, and attractive yields supports a cautious but optimistic outlook, in our view. Fundamentals remain solid, and while US credit may not offer much excess return relative to Treasurys, yields and total return expectations are attractive, in our view. In the near term, we believe any periods of weakness or spread widening may present opportunities to add exposure selectively.

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