Earnings season reveals the mood of corporate America

Earnings reports are like report cards for corporate America, and they can tell you a lot about what the economy is doing and what to expect. Alphabet reported disappointing earnings on Tuesday: revenue growth slowed to 6% this year from 41% last year. Elsewhere, payroll processor ADP reported higher earnings on Wednesday that surprised investors.

Most S&P 500 companies have met earnings expectations so far this season.

“I think the sentiment in the reports has been generally positive,” said Alex Zukin, managing director of Wolfe Research. “That view is making people a little hesitant.”

A forecast is the part of an income statement that tells companies what they think will happen down the road. For example, Microsoft has suggested slowing demand for some of its products, Zukin said. Some other red flags Zukin sees are companies suddenly focusing on cutting costs.

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“How do we make sure that every dollar we spend is going the right way?” he said. “These two things are generally an ominous sign for the demand environment going forward.”

And there is a significant difference between companies with a negative outlook or bad earnings and companies that don’t.

“It depends on who you’re selling to,” said Michael Walker, an analyst at asset management firm AllianceBernstein. “If you’re selling to consumers or dealing with consumers and individuals, you’re doing well now and the outlook for next year is actually pretty good.”

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The labor market is in good shape, so it’s no surprise that payroll processor ADP beat earnings.

“On the downside, if you sell to companies, you start to see a decline,” Walker said.

Google, Microsoft and Texas Instruments each had disappointing forecasts, and all three companies are selling businesses. These businesses will begin to feel the bite of rising interest rates — rising rates make it harder to borrow and lower stock prices.

“It comes in waves,” said Joel Pracken, chief U.S. economist at S&P Global Market Intelligence. “For example, we saw that the housing sector was the first sector to respond through contracting.”

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After that, he says, business costs for equipment will decrease.

“Somewhere in the surplus, you’re going to see a drop in spending on durable goods,” he said.

All of this will show up in the income statements over time.

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