As we know, companies beating analyst estimates isn't really a big deal. After all, analysts need to maintain access to management and ensure everyone is sending buy orders through the brokerage, so it makes little sense to set expectations too high.
However, the way companies are exceeding analyst expectations is worth noting. According to a survey by Morgan Stanley, analysts responded that if firms exceed expectations to the upside, it was typically due to lower costs than higher revenues. Said otherwise, companies are not generating the top-line growth necessary to beat even the lowest of analyst expectations, and have focused on driving cost out in order to meet the street's expectations. After all, if the numbers miss, executives don't get as much out of those options and RSUs, and we can't be having that.
From Morgan Stanley
At the economy-wide level, corporate profits were down 7.1% year/year in 1Q16, a fourth consecutive decline, and after-tax profits have fallen 15.5% in the six quarters since their peak in 3Q14. With profits coming under pressure, analysts' responses in our survey have increasingly pointed to lower costs (expenses) as the primary reason why companies have exceeded estimates to the upside, while higher top-line growth has been cited much less frequently as a driver of any upside in earnings.
Cost reduction efforts lead to another important discussion, which is that if firms are reducing costs so the street is happy, then implicitly hiring is not part of the future plan. This is confirmed with Morgan Stanley's hiring plans index, which has grown increasingly worse since the end of 2014, with cost reduction efforts intensifying shortly thereafter.
The cost reduction efforts along with lower plans for hiring have of course led to a slowing trend in actual payroll growth, as MS points out.
The slowdown in hiring plans has tracked the trend of cost-reduction in company earnings fairly closely (Exhibit 4), and has also coincided with the slowing in trend payroll growth (Exhibit 5), offering some evidence that headwinds from earnings pressure in the corporate sector may indeed be a factor behind the recent slowdown in hiring.
All of this of course leads to payroll numbers like we saw for May, when a meager 38,000 jobs were added.
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The overall point is that companies aren't getting the top line cover needed to hit analyst estimates and are scrambling to reduce costs. As this cycle occurs, typically hiring freezes are implemented and it's not unheard of that merit increases get frozen as well at the end of the year. If one believes that the global economy will pick back up and help revenues recover, then this isn't something to worry about – however if the opposite is true, then cost cuts will continue to intensify and we could be in for more dismal and "unexpectedly light" earnings and jobs numbers in the future.
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