Cost Pressures Aren’t Yet Crimping Corporate Profits

Actual earnings per share will almost certainly be better. Analysts have a tendency to low-ball their forecasts, and the third-quarter estimates appear unusually low. S&P 500 earnings are expected to show a sequential decline of about 7% from the second quarter, when the more typical seasonal pattern would be for them to rise a bit. Moreover, although the U.S. economy might have slowed somewhat in the third quarter compared with the second, it still looks as if it grew, while the global economy made headway as well.

With supply chain bottlenecks pushing material, equipment and shipping costs up, and the challenge of finding workers sending labor costs higher, you can see why analysts might be a bit more cautious on their estimates. But a look through some of the economic data suggests that, at least in aggregate, profit margins aren’t coming under pressure yet.

For example, Labor Department figures show that wholesale prices for finished consumer goods, excluding food and energy items, were up 4.7% in August from a year earlier. That was the biggest gain in over a decade. But prices consumers paid for goods excluding food and energy were up 7.6% on the year in August. The two data series aren’t strictly comparable, but it sure seems as if companies might be having some success in passing their costs on.

Wages are on the rise, too. In the first two months of the third quarter, an aggregate measure of earnings from the Labor Department was up by 1.8% from the second quarter. But as this is much slower than the pace of overall economic expansion plus inflation, it seems unlikely to hit companies’ bottom lines. By a similar token, a measure constructed by UBS strategists indicates the prices that companies in the S&P 500 are charging are rising faster than their wages are.

Still, for some companies the good times have probably come to a close. Passing on higher costs isn’t something that all companies can do with ease. If they are selling something for which there are cheaper substitutes—say, a brand name with little differentiation from private-label alternatives—charging more might not be so easy. The same goes for discretionary items that people can easily do without, or categories that people just expect to stay cheap, like pizza.

Moreover, in some areas cost pressures are more intense than others. Wage growth for workers with lower paying jobs has been rising much faster than for people with fatter paychecks. For businesses that tend to hire lower-wage workers, such as restaurants (which are also dealing with higher food costs) that is less than ideal.

For the most part, third-quarter earnings reports should look very good, but some investors could be in for a bad experience nonetheless.