Over the weekend, we suggested that an earnings recession might be just around the corner for the US.
While the tax overhaul catalyzed three quarters of blockbuster bottom line growth for corporate America, management teams are now 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 earnings growth.
Indeed, Q4 profits are on track to grow at just half the YoY pace seen in Q3 and analysts are now projecting profit growth will turn negative for the first time in three years when companies report results for the first quarter. Here, for those who missed it, is the chart:
The bottom line (figuratively and literally in this case): although analysts still expect just one quarter of shrinking profit growth, an earnings recession is looking more likely by the week.
Of course no discussion about a prospective earnings recession is complete without a mention of Morgan Stanley’s Mike Wilson, the man who called last year’s Tech/Growth selloff and who, in November, suggested that multiple quarters of negative earnings growth are a real possibility in 2019. That’s why we closed our weekend post on the subject with the following:
Maybe Morgan Stanley’s Mike Wilson will be proven right again.
Well, cue Mike Wilson.
In a note dated Monday morning, Mike has a simple message: The earnings recession, he says, “is here”.
“Our earnings recession call is playing out even faster than we expected”, he writes, adding that when he made his “call for a greater than 50% chance of an earnings recession this year” he figured “it might take a bit longer for the evidence to build.”
Suffice to say the “evidence” is accumulating pretty rapidly.
After flagging consensus estimates for negative projected growth in Q1, Wilson notes that folks are now assuming a “hockey stick” in H2 in order to get to 5% growth for the full year. That, he cautions, is probably too optimistic.
“The projected YoY EPS growth in 4Q19 is ~9.5%… compared to an average projected rate of growth of 1% over 1Q-3Q19, an inflection of ~8.5%”, he goes on to write, describing the hockey stick projections, before reminding you that “since the early 00s, we have seen this kind of inflection happen a few times but these inflections were all related to 1) comping against negative or slower EPS growth or 2) tax cuts mechanically lifting the growth rate.”
Now you can (hopefully) see the problem. Not only are neither of those the case in 2019, comps will instead be extremely challenging. At the same time, the three-headed margin Cerberus mentioned above will continue to crimp bottom lines. That means the inflection baked into consensus is exceedingly far-fetched.
“Anything is possible, but we have little confidence in such an inflection given sharply falling top line growth and disappointing margins in the face of very difficult comparisons for the rest of the year”, Wilson muses, underscoring the points made above.
Long story short, Morgan Stanley is lowering their EPS growth forecast for 2019 to just 1% from 4.25% previously.
You’ll note that the bank’s S&P targets remain unchanged thanks to support for projected multiples courtesy of a lower rate environment.
That said, Wilson says the “odds of outright price declines are substantially elevated”. Either way (i.e., whether stocks do in fact head lower or manage to post positive returns in spite of disappointing results), Mike says “volatility will likely rise meaningfully.”
Can he back up that claim about volatility with any math? As it turns out he can – and does. The chart below shows that when consensus is embedding the kind of hockey stick inflection for earnings growth that’s currently projected for late 2019, realized volatility on the S&P rises to an average of 21.6% versus an unconditional 16.5% (the figures for the median tell a similar story).
So, there you go, sports fans. If you were wondering whether Mike Wilson noticed that his earnings recession call is getting closer and closer to being realized, the answer is “absolutely he noticed”.
And not only that, he believes the earnings recession is in fact “already here.”