Back on December 30, as the worst year for US stocks since the crisis was drawing to a close, we suggested that insanity had become contagious. Market participants had become trapped in a reality distortion loop, seemingly unaware of their own role in shaping the narrative that served as the impetus for the selling.
The underlying force that binds everything together – the process – was that fear had become the new cognitive principle. And fear is self-reinforcing. If you spread fear, it looks like you have a deep knowledge of things. If you are calm, it is like being ignorant.
At the time, we showed you the following chart of quarterly earnings versus the quarterly performance of the S&P:
Sure, markets are forward-looking, but that represented the S&P diving nearly 15% following three consecutive quarters of 22%+ profit growth.
To be sure, there were plenty of reasons to suspect that earnings growth was set to fall precipitously. After all, US corporates are staring down a trio of daunting margin headwinds: rising wages, higher interest rates and tariff-related input cost pressures. Throw in the fact that the fiscal impulse was/is set to wane stateside and factor in a slowing global economy and you’ve got a recipe for a sharp slowdown in profit growth.
Indeed, there’s a solid argument (largely predicated on the above-listed factors) in favor of 2019 witnessing an earnings recession. Morgan Stanley’s Mike Wilson cautioned on that back in November.
Fast forward a month and two thirds of the S&P has reported Q4 results. Generally speaking, earnings season has gone ok, albeit against lowered expectations.
“47% of firms have beaten consensus EPS estimates by at least 1 standard deviation [and while] the percentage of firms beating on the bottom line has moderated from 56% in 3Q, [it] remains in line with the long-term average”, Goldman wrote on Friday evening, adding that “EPS grew by 14% during 4Q, up from the 12% consensus forecast prior to the season [and] as a result of low investor expectations, firms beating on the bottom line have outperformed S&P 500 by 247 bp on the day after reporting earnings, the highest magnitude of outperformance since 3Q 2009.”
Read more on earnings season
Looking ahead to Q1 results, the picture starts to get a bit murkier. Here’s what we wrote on Thursday:
It seems likely that the real impact of slowing global growth, trade uncertainty and domestic political turmoil won’t show up until Q1 2019 results.
That may be the real litmus test and assuming the YTD rally has legs, any disappointments when we start to get Q1 results will be set against a backdrop of buoyant risk assets, a rather tenuous scenario.
Well, sure enough, analysts have been busy cutting estimates for Q1.
In fact, the Street expects profit growth to turn negative for the first time in three years when companies report results for the first quarter. Have a look:
As Bloomberg’s Sarah Ponczek writes on Friday, “short declines in profits have a habit of turning into long ones”, which means predictions of a quick snapback into positive territory in Q2 could prove optimistic in hindsight.
If we do get an earnings recession, history shows it won’t stop at two quarters. “Profit declines that extend past two quarters have virtually never stopped there since the Great Depression”, Ponczek goes on to observe, adding that “contractions of three quarters or more have triggered bear markets 78% of the time over the past eight decades.”
So, there’s some fodder for the bears.
To be sure, exactly nobody thought 2019 would look anything like 2018 for corporate bottom lines. Indeed, it was almost a mathematical certainty that earnings growth would dive. That said, there weren’t that many analysts calling for an earnings recession in the new year either.
Maybe Morgan Stanley’s Mike Wilson will be proven right again.