The earnings recession that wasn't
"This is the start of an earnings recession" has been one of the more persistent bearish arguments over the past year. I was never in that camp and it was arguably never a consensus view, but the current reporting season marks the beginning of the end of this particular reason to be bearish.
There are plenty of things to worry about, but being in the early stages of an earnings recession is not one of them.
On the surface, the bear case was backed up by data. US earnings growth slowed down through 2015 and the year-on-year growth rate of S&P 500 non-GAAP EPS turned negative in Q4 last year and fell to -6% in Q1 this year. The earnings decline seemed to be accelerating.
But beneath the headline numbers there were a lot of moving parts that suggested the growth slowdown was more benign. The biggest of these was the incredibly sharp drop in oil prices, which wiped out the entirety of earnings being contributed by the energy sector, an index heavyweight with an 11% weight in the S&P 500 in mid-2014. The oil price fall was a hit to market earnings but a relatively idiosyncratic one. Outside the energy sector, earnings growth held up relatively well, but given record margins and an unexciting global growth backdrop ex-energy earnings growth was never going to shoot the lights out. It briefly dipped into negative growth territory in Q1, but this was within the range of normal volatility at this advanced stage of the economic cycle.
What we have seen from the Q2 reporting season so far confirms our view that Q1 likely marked the trough in year-on-year earnings growth. There are still a few more results to trickle in, but US earnings look to be on track to have contracted by around 1% (after -6% in Q1) and have grown by around 3% if we exclude the still-suffering energy sector.
A return to positive growth is likely from Q3 onwards, finally putting to bed the earnings recession concerns.