S&P 500 Margins Likely To Decline in Q3: Is Anybody Out There?

The third quarter earning session began Tuesday night with Alcoa Inc. (NYSE:AA) reporting its Q3 earnings. If Wall Street analysts are to be believed, it will be the first time since Q3 2009 where profits of S&P 500 companies are likely to post a negative earnings growth over the same quarter a year ago. It’s highly unlikely that the companies would surprise pundits amid a troubled Eurozone, slowing Chinese economy, and uncertain U.S. economy. Worse, the Wall Street Journal argues that the companies have tapped the other paths of profits so much, that there is nothing left to explore now.

S&P 500 Margins Likely To Decline in Q3: Is Anybody Out There?

Earlier in July, analysts said S&P 500 (INDEXSP:.INX) would post 1.9 percent increase in Q3 earnings on the y-o-y basis. But now, the same consensus shows a 2.7 percent drop. “Earnings cannot keep growing faster than revenues,” says Jeff Kleintop, a market strategist at LPL Financial. “The latest data shows productivity plunged, which means that all the fat has already been cut.” Miners, metals producers, and materials companies will post the worst earning drops because of the falling demand in Asia, and declining natural gas prices.

The net margins have been increasing since the first quarter of 2009, not so much because of the companies reducing costs and making their employees work harder. It has been because of the falling interest rates. The margins were growing on the mercy of Federal Reserve’s aggressive easing policy, rather than corporate efficiency. Now the interest rates have reached historic lows, let’s see how much more S&P 500 (INDEXSP:.INX) companies can draw from that well.

That’s why J.S. Trennert of Strategas Research Partners says that the earnings assumptions for Q3 this year, and for the full FY-13 are based on the far too aggressive assumptions. “If companies make less money, they also hire less, and that’s not good for company profits either,” he says.

Though the third quarter earnings will contract, analysts predict a healthy rebound in the fourth quarter and the entire next year. Maybe they think so because the U.S. recovery seems to be sounder than a few quarters ago, when there were sporadic talks of the United States falling back into recession.

It still appears too optimistic. In the last few years, companies laid off workers during the downturn, that allowed margins to outpace revenues. It means the fat has already been cut, and now the companies will have to hire new employees to do the extra needed work, instead of putting the burden on the existing workers. Hiring is good for the economy, not for the margins.