- Corporate profitability has continued to improve on a global basis, with a strong pickup in demand and higher commodity prices, supporting earnings growth across developed and emerging markets.
- US corporate profitability is among the strongest, particularly tech companies that have continued to benefit from high levels of demand for digital services over the course of the Covid-19 pandemic.
- Profit margins continue to rise, and pricing power by firms suggests that they will remain elevated over the near term. That said, they could start to soften slightly over the coming quarters because of increased inventory, easing supply constraints and softening commodity prices.
In January and April, we at Fitch Solutions argued that corporate profitability was going to continue improving on the back of a cyclical pickup in economic growth and a recovery in profit margins. This view has been playing out, and despite rising inflation, we continue to expect profit margins to hold up over the coming quarters as strong demand and localised shortages provide companies with pricing power. In turn, stronger corporate profitability should help to underpin robust global growth via elevated levels of capex and hiring, and we continue to forecast global growth of 5.7% in 2021.
Estimated Earnings Roaring Back
Global - Growth In Estimated Earnings Per Share, %
Estimated earnings per share growth for the MSCI World – capturing equities in developed markets (DMs) – and emerging market (EM) indices are positive and strong, which points to a broadening of global profitability. DMs have seen average estimated earnings growth of 34.9% y-o-y (on a three-month moving average basis), while EMs have seen a similar growth rate of 34.2% over the same period. This is in stark contrast to January, when growth was still broadly negative. This can be mostly explained by the strong rebound in the global economy as well as still-elevated profit margins. For EMs, another tailwind has been a very swift improvement in global trade as well as the sharp rise in global commodity prices.
Tech And Small Caps Outperforming In 2021
Growth In Earnings Per Share, Average Change Over Three- & Five-Month Period, % y-o-y
While global corporates have done well, US corporate profitability has outperformed to a large extent, especially relative to European benchmarks. In particular, we note that small caps (136.3%) and US tech firms (46.3%) have seen estimated earnings growth outperform other sectors over the same three- and five-month period. This is largely due to strong profitability of the tech sector as well as high levels of demand for digital services over the course of the pandemic, while small caps are largely outperforming because of base effects, given the extremely sharp contraction in estimated earnings in 2020 (about a 60% decline during the worst of the pandemic).
Profit Margins Rising Modestly
Global - 12-Month Trailing Profit Margins, %
Profit Margins Already Improving And Should Remain Elevated
Despite rising global inflation in recent months – which we estimate rose to about 3.5% y-o-y – global profit margins have not only stabilised, but risen in recent months, showing an improvement in profitability. In particular, we note that EM profit margins have risen sharply to 11.0%, marking their highest level since the global financial crisis. While DMs have also seen their profit margins improve, they have risen by less than EMs and at 7.7% have not yet reached their pre-pandemic level of 9.0%. According to surveys from the National Federation of Independent Business, small businesses have been raising prices in recent months in order to protect their margins and plan to continue doing so over the coming months, which point to continued pricing power for businesses.
Small Businesses Raising Prices To Defend Margins
US - NFIB Small Business Survey (net percent)
However, we believe that over the next few quarters – and going into 2022 – profit margins will most likely stabilise and possibly even soften slightly as several dynamics play out. Shortages will most likely ease significantly over the coming quarters, and with many companies scrambling to rebuild inventories, we could see a build-up of excess inventory over the course of 2022. This, combined with a shift to greater demand for services as the global economy re-opens, could see some companies losing some pricing power. Moreover, our Commodities team believes that most of the gains are behind us and that commodity prices could start to soften slightly in H221 and beyond, which could also cap profit margins for commodity producers and EMs.
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