By Chris Matthews, MarketWatch
U.S. equity investors have been fearing an earnings recession for many months now, and by one measure, those fears were well founded.
According to FactSet data, earnings-per-share for S&P 500 /zigman2/quotes/210599714/realtime SPX +0.45% companies fell by 0.3% year-over-year in the first quarter of 2019 and are on pace to decline by 0.4% in the second quarter. Earnings recessions are popularly defined as two consecutive quarters of earnings contractions, making the current stretch the first such event since 2016.
Other data providers, including S&P Global Market Intelligence, Bloomberg and Refinitiv are reporting that S&P 500 EPS have risen in the first and second quarters of this year, with estimates for year-over-year first-quarter growth ranging from 1% to 2.5% and from 2.2% growth to 3.2% for the second, and these disparities should caution investors against placing too much importance on the concept of an earnings recession, analysts and strategists tell MarketWatch.
The discrepancies between different data providers underscore that earnings-per-share metrics can be subjective. John Butters, senior earnings analyst at FactSet, told MarketWatch that the differences can likely be attributed to whether the data provider uses GAAP or non-GAAP earnings numbers to estimate growth, how they estimate number of shares outstanding and how the provider accounts for differences in the makeup of the S&P 500 from year to year.
“Probably the biggest difference is going to be at the company level and what is included or excluded from earnings,” David Aurelio, senior manager of equity markets research at Refinitiv told MarketWatch.
For example, in 2018 Google parent Alphabet Inc. was hit with a $5 billion fine by the European Union. Revinitiv included this in its estimate of earnings last year, which makes this year’s earnings look better by comparison. Had it excluded that charge, Aurelio said, S&P 500 earnings per share would be on pace for 1.7% growth in the second quarter, rather than the 3.2% growth he estimates today.
One-time charges may be included or excluded based on analyst judgment as to whether these items distort or help clarify a company’s performance. Other recent examples that are leading to differences in EPS growth estimates include Boeing’s recent charge of $4.9 billion in connection to its troubles related to the groundings of its 737 Max airplane and Facebook’s recent $5.1 billion fine charged by the Federal Trade Commission and Securities Exchange Commission. FactSet excluded the Google fine, while including the Facebook and Boeing fines last year, Butters said, helping explain its relatively low estimates.
“There’s definitely differences among different research providers,” who estimate earnings-per-share growth, Kristina Hooper, chief global market strategist at Invesco told MarketWatch. “It’s not usually this significant, but we’ve had periods where it was as large.”
Hooper said that while an earnings recession, or a period of very low earnings growth, can signal important information about the health of the corporate sector, investors should not overestimate the phenomenon as a predictor of future performance. “Earnings recessions are a lagging indicator,” she said. “When we discuss an earnings recession, we’re looking in the rearview mirror.”
”What’s far more important is where we expect earnings to go, and that’s an even more inexact process” than estimating EPS growth during past quarters, she added. It’s more difficult in today’s environment, when corporate performance is so heavily dependent on the outcome of the U.S.-China trade battle.
“A lot of this has to do with where the tariff wars take us,” Hooper said. “There’s no playbook for tariffs.”
Randy Frederick, vice president of trading and derivatives at Charles Schwab said that the concept of an earnings recession is useful for distinguishing a period of weakness in corporate performance with the overall economy. “Just because we might have a slight decline in earnings growth doesn’t mean that we’ll have a full blown recession,” he said.
This distinction is important because economic recessions usually lead to poor stock market returns in the short run, but that isn’t the case for earnings recessions. During a four-quarter period of negative earnings growth from July 2015 through July 2016, the S&P 500 index rose 1.2%. During the 2008-2009 economic recession, meanwhile, stocks fell 35.5%.
Regardless of methodology, its also worth keeping in mind that trends in S&P 500 earnings don’t necessarily reflect trends seen by the typical public company in America. Weighted by market capitalization and designed to track the roughly 500 largest companies in America, data on S&P 500 earnings growth can be skewed by the performance of a few very large companies.
The small-cap Russell 2000 index /zigman2/quotes/210598147/delayed RUT +0.32% is widely agreed to be in an earnings recession, with double digit percentage declines in earnings per share growth in the first quarter followed by another contraction in the second. For the third quarter, analyst estimates for growth have fallen to negative 6.1%, according to data from Jefferies.
Meanwhile, large-cap earnings growth is slowing by most estimates, if not outright shrinking. Refinitiv, whose earnings growth estimates for the second quarter have been higher than most, still predicts a 1.9% earnings contraction for the third quarter.
“There’s a large list of indicators that are pointing to the idea that we’re coming to the end of the business cycle,” including an inverted yield curve and the recent outperformance of defensive stocks Frederick said. Though he doesn’t forecast a recession in the near term, “that earnings growth is starting to level off or decline is just one more item on that list.”