Corporate Health Stabilizes, but We Expect More Weakness Ahead

After falling steadily for most of the past year, our latest quarterly survey of Loomis Sayles’ credit analysts revealed that two key measures of corporate health, pricing power and margins, showed signs of stabilizing in the first quarter of 2023. Inflation ticked down as well. But we think the hints of better news should be kept in perspective. Our credit analysts, who track 28 different industries, expect further deterioration ahead in pricing power, margins and credit quality. In six industries, including financials, our analysts see the risk of a crisis trending higher. A profits recession, which could trigger layoffs, is a distinct possibility in the months ahead. In short, we don’t think we’ve seen the bottom yet in corporate fundamentals.

Why pricing power matters

We have emphasized the importance of weakening pricing power in past reports. When firms can’t pass on rising costs to their customers, two things tend to happen: profit margins come down and so does inflation. We have seen evidence of both. Inflation has diminished but remains far above the Federal Reserve’s 2% target. Margins have come down too, yet because they started their decline from lofty levels, they remain respectable by historical standards. Defaults are still infrequent.