Earnings from the first quarter are almost all in -- and most companies in Europe and the U.S. managed to beat analyst estimates. That's no reason for bond investors to celebrate.

Of the 458 companies in the S&P 500 that have reported, almost 75 percent beat consensus forecasts, according to Bloomberg data. In Europe, more than half of the 343 companies in the Bloomberg Europe 500 Index surpassed expectations.

Beating Estimates
Number of S&P companies reporting quarterly earnings that beat estimates
Source: Bloomberg

Of course, if the bar is set low enough, anyone can work the numbers to exceed -- and analysts had been cutting their estimates for the quarter in the weeks before it ended.

Me, Too
A majority of European companies beat estimates as well
Source: Bloomberg

It isn't enough to simply look at headline earnings: the means by which companies are improving is critical to their ability to support their debt burden. Cost-cutting initiatives may flatter and bolster profit in the short-term, but cost-reduction (together with margin expansion) is a finite strategy.

Look at earnings and sales growth, and a more troubling picture emerges for credit investors: in Europe, aggregated earnings shrank 27 percent and sales by almost 9 percent. The picture in the U.S. was slightly better, albeit still with declines of 9 percent and 2.4 percent.

Growth Trends
Aggregate sales and earnings both fell in the first quarter
Source: Bloomberg

In Europe, the biggest part of that decline was generated by oil and financial services companies, unsurprising given the decline in the oil price and investment banking revenue. Only three industries -- healthcare, telecommunications and technology -- achieved positive revenue and profit growth in the quarter. 

Growth Trends
Only three industries showed aggregate growth in revenue and earnings
Source: Bloomberg

Look back over the past three quarters, and the picture is even more concerning. Revenue in the U.S. has undershot estimates for three consecutive quarters.

Undershooting Expectations
Aggregate revenue has missed estimates for three quarters now
Source: Bloomberg

But corporate bond spreads don't reflect these deteriorating fundamentals: investors are getting a smaller premium for holding high-yield corporate debt instead of government securities over a comparable maturity. Part of that is, of course, the result of the European Central Bank's imminent purchases of company debt and the shortage of high-yielding assets in a world of low interest rates.

Tightening Spreads
Investors are getting a smaller premium for buying high-yield debt
Source: Bloomberg

It's not as though the warning signs aren't flashing: S&P Global Ratings expects the rate of defaults among junk-rated U.S. companies to jump from 3.8% in March 2016 to to 5.3 percent in March 2017.

At some point in the not-too-distant future, when focus surely returns to credit quality metrics, investors and borrowers will be in for an uncomfortable reality check.

(Simon Ballard is a Bloomberg First Word strategist covering credit markets. His opinions are his own and aren't intended as investment advice.)

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Simon Ballard in London at sballard20@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net