This Earnings Recession Can No Longer Be Ignored

It was not until after the stock market correction in late August that I finally heard the intelligentsia on CNBC discuss the possibility of a corporate earnings recession in the US, and what implication that might have for the stock market. All it took was a gut-wrenching decline of 11% for the S&P 500 (SPY) over five consecutive trading days to stir this intellectual awakening.

In reality, the recession in corporate profits they were pondering began more than a year ago, but you wouldn’t have heard mention of it if your news sources were the companies that aggregate the earnings data, the Wall Street analysts that assess the earnings numbers or the actual companies themselves. This is because they are all culpable in excluding a variety of costs and expenses from the bottom line that are not unusual one-time items, but are instead recurring expenses that are a normal part of running a company year after year. It is this “adjusted” earnings number that is emphasized by corporate managements, used by analysts to assess fundamentals and make recommendations, and aggregated by the likes of Thompson Reuters, S&P Capital IQ and FactSet to provide investors with sector and index earnings data. It is a mirage, and it has grown more arrant with each passing year, while the stock market indices have climbed to successive new highs.

The divide between these “adjusted” earnings numbers and the actual bottom line that companies are also required to report, following generally accepted accounting principles (GAAP), is a gap that has continued to grow year after year. In a recent study by The Associated Press, 72% of the companies in the S&P 500 had “adjusted” earnings that were higher than the bottom-line operating earnings number. The gap between the two numbers has grown from what was 9% five years ago to 16% today. The number of S&P 500 constituents that reported an “adjusted” earnings number that was more than 50% higher than the bottom line had grown from 13% to 21% over the same time frame. This is reminiscent of the dot-com days.

The bad news for those embracing these “adjusted” numbers is that despite the ever-growing amount of deception built into them in an effort to build shareholder value, they are now rolling over on a year-over-year basis for the second quarter in a row. That is the definition of a corporate earnings recession. The data provided by FactSet in the chart below shows that S&P 500 earnings declined 0.7% year-over-year in Q2, and are on track to decline 2.2% in Q3 should companies continue to beat quarter-end estimates at the same rate they have over the past four years. Again, this is an earnings recession using an extremely aggressive number…

Please click on the link to read more of my article on Seeking Alpha.

Leave a Reply