Earnings season starts this week and the news is expected to be disappointing. Bloomberg is projecting S&P 500 earnings in the second quarter 13.8% lower than the same time last year, and earnings could be negative again in the third quarter. Two negative quarters in a row is the classic definition of a recession.
While this may sound alarming, and while the trend is clearly weak, once you unpack the numbers it does not look so bad.
Let’s start with the good numbers. First, margins are near cyclical highs. Much lower corporate taxes, lower interest rates, lower energy costs, contained wage growth since the great recession and above trend U.S. GDP growth have plumped up earnings over the last few years. A pause in growth should be expected at some point.
Quarterly S&P Sales and Earnings Trends
Moving on to the bad numbers, GDP growth is fading around the globe, tariffs are a drag on earnings (remember tariffs are just another tax), a stronger dollar is hurting exports, emerging wage inflation is starting to impact earnings (as unemployment rates reach a 50-year low) and capacity constraints have led to higher transportation and logistics costs.
So, are investors correct in being so blasé about weaker corporate earnings? At the end the day it is hard to get worked up about a pull-back in corporate earnings when the Fed and the ECB (and just about every other central bank) are loose and expected to loosen further. China is ready and able to support its economy if needed, fiscal policy around the world remains loose and the U.S. consumer is doing well.
As we mentioned last week, we will all be looking for the proverbial green shoots in earnings and GDP to confirm central bank loosening will sustain this long running economic recovery. But until we see some evidence, as well as perhaps some happy guidance this earnings season, we prefer staying conservative and liquid with the conviction there will be better opportunities ahead.
Sources: Bloomberg, Goldman Sachs, the Financial Times