FT, Nov. 9 2015 US is suffering a profits recession by Russ Koesterich It is easy to forget that when market volatility first started to rise in late June, investors were reacting to concerns over rising interest rates and a pending Federal Reserve tightening. Since then, the focus of anxiety has shifted from rates to growth, a fear that only intensified as weakness spread from emerging markets to commodities to European exporters. Today, investors are increasingly worried that even the mighty US economy will succumb to a global slowdown.
Fortunately, signs of a pending US recession are few. However, there may be indications another “recession” has already hit: one of profits. Certainly the economy is slowing, but we are probably witnessing another reversion to the new mean of 2 per cent growth, rather than something more acute. The US is not immune to the turbulence that began in emerging markets, but some of those disruptions come with silver linings: the resulting drop in rates and energy prices both support the US household sector. There is also little risk of the Fed prematurely derailing the recovery. Given the recent collapse in inflation expectations, an aggressive Fed is arguably the least of the market’s worries. Leading indicators also provide some comfort. Before the last recession there were red flags. Several leading indicators, including the Conference Board’s Index of Leading Indicators as well as the Chicago Fed National Activity Index, began a steady decline in the spring of 2006, a full 18 months before the start of the recession. Now, few measures are suggesting robust growth but instead a slow but positive expansion over the next three to six months. That said, this relatively sanguine outlook comes with an important caveat: few indicators provide much warning outside of the next few quarters. A recession may not be lurking before next spring, but the outlook gets cloudier the farther out you look. However, while the US may not be at imminent risk of an economic recession, the disappointing earnings companies are reporting suggest it may already be suffering through a profits recession. Looking back at history, profits recessions typically accompany economic recessions. This should not come as a surprise. Historically, the biggest determinant of earnings growth is revenue growth, which is itself a function of economic growth. Looking back at more than 60 years of national accounts, corporate profits data demonstrate the importance of economic growth for corporate profitability; quarterly changes in real GDP explain roughly 30 per cent of the variance in quarterly earnings growth. Given this relationship, in the absence of an economic recession why should investors worry about a profits recession? The reason is that there have been exceptions, periods when the economy was expanding but corporate profits temporarily fell. Unfortunately, those periods have coincided with two trends that are evident today: a stronger dollar and lower oil prices. The most recent example was in 1998. Despite a stellar economy, corporate profits were falling. Similar to today, part of the blame could be attributed to the strong dollar. From the summer of 1996 through the summer of 1998 the dollar appreciated roughly 20 per cent against a basket of its peers. The rapid appreciation of the dollar put a squeeze on US exporters. In contrast, the profits recession of 1986 occurred coincident to a period of dollar weakness. In 1985 the dollar started a long-term decline and, similar to today, a collapse in oil prices contributed to the following year’s profits recession. West Texas Intermediate crude, the US benchmark, fell from more than $30 a barrel in the spring of 1984 to just over $10 a barrel by July of 1986. What do these incidents suggest about the current situation? While we are probably experiencing a profits recession, or at least a profits drought, it should not be long or deep. With US growth on a lower than expected trajectory and the Fed likely to be particularly timid in raising rates, further dollar appreciation is likely to be more muted and slower. As for oil, in the absence of another significant drop, the negative impact of lower oil should start to fall out of energy company earnings by the first quarter of next year. Investors looking to 2016 should look past this temporary profits drought and focus on the real economy. How the US fares in 2016 is likely to hold the key to whether the current profits blip is simply an interruption in the bull market or the beginning of the end. Russ Koesterich is global chief investment strategist at BlackRock _______________________________________________ pen-l mailing list [email protected] https://lists.csuchico.edu/mailman/listinfo/pen-l
