Global earnings peaked in August 2014. Since then they have declined 14%. At the same time, equities have rallied 25%. This is according to a note written by Andrew Lapthorne, head of quantitative analysis at Société Générale. Lapthorne forms the following and simple conclusion: “Gravity beckons!” He also wrote: “MSCI World EPS is now declining at the fastest pace since 2009.”

Expectations vs. Reality

Through May 9, 87% of S&P 500 companies reported earnings and 71% beat bottom line expectations. Over the same time frame, profits have declined 7.1% year-over-year.

This sends a mixed signal. First quarter expectations were exceptionally low, which allowed the majority of companies to beat on the bottom line. However, the S&P 500 has now seen three consecutive quarters of negative earnings growth. Two consecutive quarters of negative earnings growth makes for an earnings recession.

Loeys On Earnings

According to a note recently written by Jan Loeys, global strategist at JPMorgan Chase & Co., similar periods of earnings declines in the past have either led to “strong fiscal or monetary stimulus or strong growth in productivity.” Loeys went on to write that central banks aren’t having as much of an impact in the past and that with falling productivity, "It is much harder to expect higher company earnings over the next year.”

Loeys sees one of two possibilities: dramatic policy action or recession. To Loeys contracting margins are a key warning sign of impending recession. While Loeys sees an elevated risk of recession over the next one to two years, the immediate risk appears to be low.

The answer is likely to be simple. If the U.S. can only show 0.5% GDP growth, then recession would be a probable scenario without extremely low interest rates. The dilemma is that those low interest rates are beginning to catch up with some corporations, which can’t afford to repay debts.

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