Half Way To An Earnings Recession?

The latest  compilation of analyst earnings projections by FactSet shows that Wall Street is expecting earnings for the companies in the Standard & Poor’s 500 to drop by 0.8% year over year in the first quarter of 2019. That’s down from late January projections of 0.7% earnings growth for the first quarter.

It’s likely that when all the earnings are counted, the quarter will show some growth–analysts typically lower their forecasts for a quarter at about this point in the cycle. And companies typically wind up beating the analyst forecast by anywhere from 2% to 3%.

Of course, it could be different this time. The drop in projected earnings for the first quarter of 2019 from the September projection of 6.7% is above the historical average and the drop in earnings estimates during the first month of a quarter is the largest since the first quarter of 2016.

And there are a lot of tough to predict factors out there that could hurt first quarter earnings. A tough to predict path for the dollar–Will it be up? Will it be down? And when?–could wind up taking a bite out of revenue and earnings for the quarter. Another government shutdown–with the deadline for heading that off of February 15–wouldn’t help. And no one is quite sure what the effect of the uncertainty stemming from the U.S.-China trade war will do to earnings and revenue.

But the trend isn’t a good one. Fourth quarter 2018 earnings are expected to show a 12.4% year over year rate of growth, so even if the first quarter winds up being mildly positive, it will still be a step down from the worst quarter of 2018.

FactSet is, at the moment, calculating just one quarter of negative earnings growth for 2019 but the positive numbers aren’t all that positive with just 1.6% year over year growth for the second quarter and 2.7% year over year growth in the third quarter. The fourth quarter, which not so long ago looked likely to see a resumption of double-digit year over year growth, now is projected to show 9.9% growth.

You’d be right to lay a major portion of the drop in earnings growth to the tough comparisons with 2018 when the December 2017 tax cuts added, according to Credit Suisse, about 7% to 8% to 2019 earnings. Not only do companies face tough comparisons to that one-time 2018 jump in earnings, but the reversal of some one-off deductions for 2018 is expected to knock about 1% off earnings in 2019, Credit Suisse calculates. But since market valuations reflect the boost to earnings from that tax cut, I don’t think that explanation carries much comfort.

If, by analogy to the economy, its takes two down quarters in earnings growth to qualify as an earnings recession, then so far we’re no more than half way there–if the negative projections for the first quarter hold up.

But remember that the stock market, as we know from the experience of the end of 2018, is quite capable of scaring itself into a major sell off on fears of something that hasn’t and maybe won’t come true.

At the end of 2018 that fear–and the sell off–was about the possibility of an economic recession. And that still hasn’t materialized with even the pessimists/realists at the Congressional Budget Office projecting that the economy will grow by 2.3% in 2019. (That is down from the prior projection of 3.1% growth from the CBO.)