Positive Momentum in Corporate Health Has Throttled Back

Our latest analysis of corporate health highlights a modest divergence between the positive momentum of S&P 500 Index earnings expectations and the slightly more cautious views from our team of credit analysts.

Forward earnings estimates, which typically come down in the first six months of the calendar year, have held up surprisingly well for full-year 2024 and 2025 due largely to strong broad-based economic activity. Current consensus forecasts imply earnings growth could broaden across most sectors outside of tech and its adjacent industries. If realized, these optimistic expectations would be highly bullish for the overall market and credit health. From the bottom-up perspective of our credit analysts, however, the six-month outlook doesn’t look quite so rosy.

Below, we examine some of our key research findings from our June 2024 survey of Loomis Sayles' credit analysts, known as the CANDIs (Credit Analyst Diffusion Indices).

Select sector challenges amid a stable credit outlook

Our analysts' overall credit outlook remains above its level from six months ago, but it has decreased markedly from March levels driven by less-rosy expectations in the services sector. Among the industries with deteriorating outlooks are automotive, construction machinery, energy – refining, specialty finance and retail. The retail industry is grappling with increasing labor costs and what is known as “shrink,” a term representing the value of stolen merchandise.

Despite the quarter-over-quarter decline, the outlook for credit appears to be in good shape. According to our analysts, the credit outlook is stable or improving for 24 of the 29 industries covered in this quarter’s survey. Furthermore, nearly all of our analysts noted that their credit outlook wouldn’t be at risk of a downgrade in a higher-for-longer macro scenario, whereby the Federal Reserve holds rates steady through early 2025.

Moderate increase in margin pressure

Our credit analysts’ expectations for profit margins were dialed back in the June survey, driven by signs of increasing costs across the board. This more subdued outlook marked the end of a positive trend that began in early 2023.

Nearly one-third of the industries we track in the survey are now signaling margin pressure, up from 20% in March. In the near term, profitability in the health care, energy and materials sectors is expected to be challenged. That said, the overall margin picture looks healthy, in our view. With margins remaining close to all-time highs, we believe a modest deterioration is unlikely to trigger a risk-off or credit-spread-widening event.

Pricing power ticks lower: a silver lining

Our analysts' outlook for pricing power has been trending higher since late 2022 but remains comfortably below levels that would suggest inflation pressure is on the horizon, in our view. While pricing power ticked lower in the June reading, most industries are relatively unchanged outside of some incremental weakness in the retail sector. Deteriorating health among low-end consumers, softening demand from high-end consumers and a general preference for purchasing experiences over goods represent additional headwinds for many retail operators, particularly those more leveraged to apparel and other discretionary goods.

In our view, the sequential decline in the CANDIs' pricing power reading offers a key positive macroeconomic takeaway. Weakening pricing power suggests the disinflation trend will continue, which could manifest itself through lower interest rates and promote an extension of the credit cycle.

Corporate fundamentals may get choppy

The June CANDIs throttled back the positive momentum we'd seen in corporate health over recent quarters. With a reversal in key metrics like profit margins and our credit outlook, we think bottom-up fundamentals could start to get choppy. That said, we don't see any red flags for corporate health just yet. If profit growth is able to find more balance across sectors and companies succeed in posting earnings near the market's lofty goals, we believe the environment for risk assets should remain favorable.

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