According to Wall Street forecasts, corporate America faces its biggest drop in profits since the early stages of the Covid pandemic as high inflation squeezes margins and fears of a looming recession dampen demand.

Companies in the S&P 500 index are expected to post a 6.8% drop in profits in the first quarter from the same period a year earlier, according to analyst estimates compiled by FactSet. It would be the biggest drop since falling more than 30% in the second quarter of 2020, which came as the rapid spread of the coronavirus led to a widespread economic shutdown.

Ahead of the first-quarter earnings season, which begins with a trio of major banks reporting results on Friday, sectors such as energy and consumer discretionary are expected to post strong year-over-year earnings growth. However, the combination of sluggish consumer demand, tighter credit conditions and lower commodity prices has lowered earnings expectations across a wide range of industries.

“When you look at the cost of wages and the cost of capital, I think margins are under considerable pressure,” said Jack Ablin, chief investment officer at Cresset Capital. “Companies were enjoying nominal growth, they had some pricing power, but their volumes were shrinking or just staying the same.”

The gloomy outlook of Wall Street analysts belies a relatively buoyant market, with the S&P up more than 6% since the start of the year. Yet just 20 stocks accounted for nearly 90% of that rise. Falling interest rate expectations boosted the appeal of some of the biggest tech companies, a development that masked a lackluster performance in the broader stock market.

Analysts had higher expectations ahead of the quarter, forecasting a 0.3% decline in earnings on Dec. 31. While earnings forecasts typically decline over a quarter, they did so more than the five-year average in the first three months. of 2023. Only the utilities sector ended the quarter with higher expectations than at the start.

More companies than usual reported weakness in the first quarter, with 78 of them issuing negative earnings-per-share forecasts – an indication that management expects to miss analysts’ forecasts – beating the average over five years by 37%. The semiconductor industry, which is part of the broader information technology sector, issued 11 such warnings.

Of the 11 sectors in the S&P 500, materials are expected to be the hardest hit, with a forecast decline of 35.6%.

“Normally you see material prices and earnings fluctuating in anticipation of a recession,” said Brad McMillan, chief investment officer at Commonwealth Financial Network. “Companies are cutting spending in anticipation of slower sales in the future.”

New orders for durable goods in the United States fell for the second consecutive month in February, as analysts expected a rebound in purchases.

As purchases of goods slow, a rise in spending on services is expected to make consumer discretionary the best performing sector in the quarter with earnings growth of 34%, driven by strength in hospitality-related industries. Profit growth in the airline industry is expected to put the industrial sector in second place at 12.6%.

Despite the recent turbulence in the US banking sector, the financial services sector is expected to register a 2.4% increase in profits and lead all sectors in terms of revenue growth at 9.1%, against an average of 1, 8%. Citigroup, Wells Fargo and JPMorgan Chase release all of their first-quarter results on Friday before the market opens.

“Given that the recent bank failures occurred in the final weeks of the quarter, the full impact will not be recorded in first-quarter reports,” Goldman Sachs analysts wrote in a note to clients.

But the failure of three banks this year could put pressure on small and medium-sized businesses for the rest of 2023, according to Ablin.

Unlike large companies that have “virtually unlimited access” to capital, “I think small and medium-sized businesses are likely to be increasingly disadvantaged by the credit crunch,” he said.