Declining U.S. Corporate Profits Signal a Looming Recession

U.S. earnings have declined for four straight quarters, and market participants are taking notice. Yet making the rounds is a dangerous narrative: that a cyclical fall in profits can occur without the rest of the economy turning down — a so-called earnings recession or profits recession. In reality, however, profits are the heart and soul of the business cycle, not an accessory.

Profits lead other economic activity, and the reason is self-evident. Rising profits cause businesses to increase production, orders, employment and capital investment. Conversely, profits declines lead businesses to retrench by cutting these activities. These reactions cause the changes in private unemployment and gross domestic product that characterize the business cycle.

盈利中最适度的涨幅伴随着一般经济活动的削弱。利润的大幅下降伴随着经济活动的彻底收缩。在目前的情况下，收益从一年前从两位数字下降，警告经济衰退正在敲门。

Year-long earnings declines seldom occur outside of broad-based economic declines. In fact, only twice in the past 50 years have earnings per share of the Standard & Poor’s 500 been negative year-over-year for four straight quarters and then recovered without the economy falling into an official recession, as defined by the National Bureau of Economic Research. Yet the factors that enabled the economy to weather the earnings declines in those two periods — 1985–’86 and 1997–’98 — are lacking today.

First, the Federal Reserve cut short-term interest rates — by 200 basis points in 1985–’86 and by 75 basis points in 1997–’98. In contrast, today there is next-to-no room for the Fed to cut rates. Interest rate declines in the earlier instances triggered soaring asset prices and big capital gains, which meant increasing wealth and improved expectations. These conditions encouraged businesses to increase borrowing, hiring and investment despite weakness in operating profits.

Second, increases in private sector debt will be more difficult today. At the beginning of 1985, private nonfinancial sector debt was 105 percent of GDP; in 1997, it was 118 percent. In both instances, this ratio increased sharply in the following years, powering investment and profits. Today, the debt ratio is 148 percent of GDP, higher than any period prior to 2005. A significant rise in leverage from the current level would require notable easing of credit standards and would take the economy back towardthe peak levels that triggered financial instability in 2007–’08。

Finally, the other advanced economies were growing robustly in 1986 and 1998. As a result, U.S. exports were able to grow strongly. Fast-forward to today, and the other advanced economies are growing tepidly and some appear to be already in recession.

Indeed, in 2015, U.S. profits have only begun to feel the effects of deteriorating global conditions. Thedeceleration of global trade is becoming an outright contraction。金融市场紧缩ing worldwide, gradually choking off the oxygen of the global economy: credit. Investment in the machinery, rigs and transportation equipment that service global commodity producers is in outright free fall and emerging markets’ capital spending in general keeps deteriorating. The emerging-markets countries have started tumbling into recession.

The present “earnings recession” in the U.S. in all likelihood will intensify in coming quarters. And when profits are falling and appear destined to decline further, smart money prepares for a full-blown economic recession.

David A. Levy是董事长Jerome Levy Forecasting CenterLLC是一种宏观经济咨询公司，为客户提供研究和投资战略服务。