Earning recession

Posted By Darren Winters on Nov 25, 2019


Earning recession

The S&P 500, which tracks stocks of 500 large-cap companies, is officially in an earnings recession.

Q3 earnings 2019 have declined -2.3% which marks the first time the index has reported three straight quarters of year-over-year earnings declines since Q4 2015 through Q2 2016, according to FactSet.

An earnings recession is defined as two consecutive quarters of year-over-year declines 

So the latest Q3 earnings 2019 has clocked that number to 3 consecutive quarters of year-over-year declines, which is confirmation that and earnings recession is now well underway.

But it might also be worth keeping in mind that corporate earnings are not a forward-looking indicator since it is a snapshot of corporate activity over the previous quarter. 

So when market watchers talk about an earnings recession, they are looking in the rear-view mirror similar to chartist and technical analysts.

Cyclical companies have been the biggest under-performers in Q3, thereby contributing the most to an earnings deficit which has cemented an earnings recession

Earnings recession

Cyclical companies make and/or sell discretionary items which are non-essential items, such as recreation and entertainment, that consumers purchase when they have enough income left over after paying the necessary expenses such as the mortgage and/or rent and utilities. So when the economic cycle turns lower consumers respond rationally by cutting back on their spending. 

If you can accurately forecast where the economy is or likely to be heading in the economic cycle then you are likely to forecast with accuracy the trajectory of earnings for cyclical companies.

So in a climate of lackluster consumer spending, cyclical companies tend to under-perform during earnings season. 

Materials and Energy were the worst performing sector adding to the Q3 earnings recession

Both sectors, Materials, and Energy had respectively 54% the lowest percentages of companies reporting earnings above estimates. 

An earnings recession can also provide investors with winners

Some companies are somewhat recession-proof and can still turn over profits even when consumers are tightening their belts.

For example, consumer non-discretionary spending is less impacted adversely in an economic downturn. Rent, mortgage and utilities, and pharmaceuticals are all examples of non-discretionary spending. 

So it is no surprise that the top-performing sectors in Q3, 2019 earnings where Consumer Staples, Health Care, and Information Technology which all helped to dampen the earnings recession. 

Consumer Staples unsurprisingly had 89% of companies reporting earnings above estimates.

Health Care also reported robust earnings with 86% of companies reporting earnings above estimates Information Technology came in at the third top-earning sector with 85% reporting above estimates. 

The overall three straight quarters of year-over-year earnings declines suggest that companies are deep into an earnings recession

Company analysts are also forecasting a decline in earnings in the fourth quarter. Investors are going to have to wait until the next year 2020 to see the end of the earnings recession where the analyst is forecasting a 5% to 6% earnings growth forecast for Q1 2020 and Q2 2020.

If you are scratching your head wondering where that growth will come from you are not alone. 

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