An Earnings Recession Looms

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Economic recessions are rare, but periods in which corporate profits fall for at least two consecutive quarters are not

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Earnings recessions, usually defined as two quarters in a row of corporate profits below their year-earlier level, happen a lot more frequently than economic recessions. By the Commerce Department’s measure of after-tax profits, there have been 19 earnings recessions since 1948. Put those profit figures into real, or inflation-adjusted, terms and the number of earnings recessions bumps up to 22. Unsurprisingly, many of those earnings recessions were associated with poor stock-market performance.

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Analysts think that the second quarter will be a rough patch for earnings, but the setback will be only temporary. For companies in the S&P 500 they estimate second-quarter earnings per share will be 5.7% above their year-earlier level, according to Refinitiv. That would probably leave them down in inflation-adjusted terms. Then they expect growth to rebound, with earnings up 10.8% in the third quarter and 10.7% in the fourth.

But considering the environment the S&P 500’s constituents are operating in, the earnings outlook might be far worse than analysts expect.

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For starters, there is the fact that the economy is slowing from last year’s heady pace. In figures released Friday, economists surveyed by the Federal Reserve Bank of Philadelphia forecast that real gross domestic product will grow at a 2.4% annual rate through the final three quarters of this year, which is decent but still a big step down from last year, when it grew 5.5 % per quarter. That is essentially akin to saying that US companies’ domestic sales will slow—a growth that in conjunction with a tight job market that is increasing companies’ labor costs could put pressure on profit margins.

Compounding the problem, the composition of the US economy is changing. The pandemic spurred heady demand for goods—a shift that played right into the stock market’s sweet spot, since far more of the companies in the S&P 500 are in the business of manufacturing and selling goods than in the economy at large. Companies such as Netflix also benefited from consumers hunkering down at home. But now with Covid-19 fears easing, consumption is moving away from many pandemic categories and back toward services, such as dining out, that are underrepresented in the stock market.

Meanwhile, the economic outlook in many of the countries where US multinationals derive sales is looking even iffier. Russia’s invasion of Ukraine is weighing heavily on the economies of many European countries. The big slowdown in China, where Beijing’s zero-tolerance strategy for controlling Covid-19 has badly dented growth, is causing ripple effects across Asia and beyond.

What is more, a strengthening dollar could further erode US companies’ overseas earnings, since they translate into fewer dollars than before. Versus the currencies of other advanced economies, the dollar is up 12.6% from a year earlier; it was down from year-earlier levels through much of 2021.

An earnings recession wouldn’t be nearly as bad as an actual recession, but for investors it wouldn’t be much fun—especially if the Fed keeps raising rates. Until it is clear that earnings can really start growing again, the stock market might not be a happy place.

Write to Justin Lahart at [email protected]

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Credit: www.Businesshala.com /

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