Corporate Health Restoration Remains on Track

Corporate health is looking brighter and brighter, according to Loomis Sayles’ Credit Analyst Diffusion Indices (CANDIs).[i] For the first time in several quarters, our analysts expect the aggregated corporate credit outlook to trend higher. Together with continued positive trends in other key measures like profit margins and pricing power, the March CANDIs suggest there is still gas left in the tank to fuel further earnings expansion, and a broad-based economic downturn has likely been pushed out on the horizon.

Trading places: credit and crisis indices flip

The March 2024 survey expressed a renewed sense of optimism, highlighted by dramatic turnarounds in the credit outlook and crisis components. These indices measure our analysts' assessment of the credit outlook and odds of a crisis in the industries they cover, respectively. In the first half of 2023, the crisis index reached its highest level since the CANDIs launched in 2021—indicating elevated systematic risk—while the credit outlook sank to its lowest level, signaling pessimism. In our latest survey, however, the credit and crisis have traded places, signaling lower odds of systematic risk and a more optimistic credit outlook. We believe that this inversion has been primarily driven by the earnings recovery in large-cap corporates.

Of the 30 industries tracked in the CANDIs, only three were identified as having deteriorating credit outlooks: specialty finance, construction machinery and auto manufacturers. Compare this to the December 2023 survey, when there were nine industries with waning outlooks. Additionally, five industries were identified as having improving credit outlooks in early 2024, three within the manufacturing sector and two within consumer services. That compares to just two industries with improving outlooks at the end of 2023.

With our preferred measure of credit risk (the aggregate of the crisis and leverage components) also in strong shape—down six points to 43.8, below the neutral threshold of 50—the overall outlook for credit looks significantly brighter, in our view.

Divergent paths for manufacturing and services

The uneven dynamics shaping the services and manufacturing sectors of the economy are once again on display. Among services companies, which represent a greater share of the US economy than manufacturing companies, costs remain at elevated levels. In the manufacturing sector, on the other hand, costs are declining markedly. We anticipate the coming ISM manufacturing PMIs could continue to exceed 50, indicating expansion.

To us, the divergence of these two sectors points to the source of inflation pressure currently in the system. As we look ahead, we think it is highly unlikely that any inflation impulse will come from manufacturing.

A healthy and sustainable margin environment

In our view, the direction of margins is one of the strongest indicators of corporate health. We’re pleased to see that margins for both manufacturing and services have climbed off the lows reached in June 2023. While our outlook for services margins didn’t change from late 2023 to early 2024, manufacturing margins appear poised to improve, in our view. The CANDIs' profit margin component, aggregating our expectations for manufacturing and services, has returned to a level of 50, conveying expected stability in profit margins. With trailing 12-month profit margins for the S&P 500 Index near an all-time high at the end of the first quarter of 2024, margins appear to be in a good place.

With inflation tamed, an extended runway for economic growth emerges

The CANDIs revealed a modest uptick in pricing power over the past six months across all industries. Although pricing power remains below the key threshold of 50, indicating less pricing power, inflation risk remains present and is something we will continue to monitor closely. So long as pricing power remains contained, we expect inflation to trend lower, paving the way for Federal Reserve rate cuts to commence later this year. We think the credit cycle has been extended, supported by solid corporate and economic health. With that backdrop, we expect the US dollar to weaken and risk appetites to grow stronger as the year unfolds.

[i] Loomis Sayles’ Credit Analyst Diffusion Indices (CANDIs) are proprietary survey-based diffusion indices that draw from the work of Loomis Sayles’ credit research analysts, who follow more than two dozen industries. The CANDIS’ output can be an indicator of how key corporate health metrics may trend over the next six months.

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