Earnings Recession Reflects Uncertainty About U.S. and World Economies
first published in The Street | Oct 22, 2015

The latest buzzword in the U.S. markets is “earnings recession.” The term is used loosely, even confusedly, but what does it really mean? How does it differentiate from a real recession and can it cause a full recession?

The earnings recession in the U.S. reflects that there have been two quarters of declining cumulative S&P 500 net earnings (earnings-per-share) across the U.S. economy. This has been the first time this has occurred since the Great Recession technically finished at the end of 2009. It ultimately reflects an uncertainty about the state of the U.S. and global economy. How long this earnings recession lasts remains to be seen.

Source: Zack Investment Research, Inc.

The puzzle, however, is that this has not translated into substantial declines in national income, that is in GDP. Real recessions are defined as two quarters of declining GDP and that has not occurred (in fact U.S. GDP rose sharply in the second quarter); hence, there is supposedly an earnings recession, but not a real GDP recession.

What’s driving this earnings recession – as many have noted, it is mainly that the crash in oil prices has badly affected results in the energy sector. Second, corporate profits, many of which are driven by export demand, are being negatively affected by the strong dollar. As usual, multiple economic paradoxes are in effect here. The knock to the energy sector from declining oil prices has generally been good for the broader economy since it reduces the cost of oil for corporates and individuals.

The dollar meanwhile has strengthened supposedly because of the stability of the U.S. economy relative to much of the rest of the world. Downward equity market adjustments may already reflect this earnings recession in stock market prices.

Various analysts seem confident this earnings recession will not translate into a full blown U.S. recession. Tosten Slok, from Deuthsche Bank, is reported to argue the earnings decline is not broad-based enough to trigger something worse. The US service sector is actually performing well, energy prices are stabilizing and the China shock is starting to become a more distant memory or is at least priced in by the market.

Other commentators are not so sanguine. They note the strong correlation between earnings declines and ultimate GDP declines. Clearly recent inactivity by the Federal Reserve on rates reflects also their concerns about the robustness of the U.S. recovery and other global headwinds. It has been 6 years technically since the last U.S. recession; that is quite a gap. In any event, an earnings recession, if it continues, is hardly likely to push the Fed to raise rates at the next window either.

There’s some truth in both these contrasting views, for there is something deeper, occurring in the U.S. and global economy. It is what Nobel Laureate Joseph Stiglitz has called the “Great Malaise,” also described by another Nobel prize-winning economist, Robert Shiller, as boom in low risk assets reflecting a global sense of angst.

While there has been modest U.S. GDP growth for some years since the credit crisis, there is also a haunting feeling that things are not right in the world — geo-politically and economically. There are limited sources of core growth in the Western world and there was no big GDP pop post the Great Recession.

With a relatively denuded Western manufacturing base, the passing of the phase of financial capitalism, and with less labor needed for basic manufacturing, no one knows the next phase in economic history. This does not necessarily produce the context for a real recession, but it does produce fear in corporate board rooms, a lack of investment, some consumer caution and a general sense of stasis.

This malaise is psychological at its heart, as so often is the case in economics. It is not altogether different from the stagnation that gripped Japan for 20-plus years. It is, however, structurally different than the Japanese case and interspersed with moments of innovation (technology, social media, fracking).

To quote J.R.R. Tolkein, “The days have gone down in the West behind the hills into shadow” – at least for moment. The malaise is both economic and reflected in rising social and cultural tensions, particularly in parts of Europe. The tensions themselves are tending to produce increasing radicalization on the right and the left. (Witness Bernie Sanders vs. Trump in the U.S. or Jeremy Corby, the new radical left leader of the UK Labor party.)

An earnings recession in the absence of a formal economic recession symbolizes confusion, business/investors struggling to understand post-industrial capitalism and stagnation as the world experiences what seems to be a heightened level of entropy.