Corporate America is entering a profit recession.
In the third quarter, earnings are expected to decline 5.1%, according to FactSet.
And after an earnings decline in the second quarter, this will mark the first time S&P 500 profitability has fallen in back-to-back quarters since 2009. Of course, this isn’t exactly news: Strategists were calling for a decline in corporate profits this year back in April.
Declines in the energy sector caused by the crash in oil prices are weighing on corporate profits, as is a decline in revenue caused by the strong US dollar. (This has also led to some looking for a “revenue recession.”)
But the worry that has cropped up as these developments come along, no matter how expected they may be, is that declines in corporate earnings rarely happen outside economic recessions.
But with the service sector of the economy still growing at a solid pace, Deutsche Bank’s Torsten Sløk – among others – thinks the broader economy is decidedly not at risk of heading into recession. In other words, we’re not looking at a real recession.
“We are experiencing a profit recession without an economic recession,” Sløk wrote in an email on Thursday.
“Lower energy prices and a higher dollar are hurting certain parts of corporate America at the moment,” Sløk wrote, “but with the China shock fading and the dollar and energy prices stabilizing it is becoming clearer that we are not about to enter an economic recession because the service sector – which makes up 85% of the US economy – is doing just fine.
“Or put differently, to generate an economic recession we need a much more broad-based slowdown across companies and that is not what we are seeing and hearing in the anecdotes during this earnings season.”
- Deutsche Bank
In his email, Sløk added that while earnings were declining, corporate profits were holding up.
But as we’ve written in recent weeks, the viability of sustained profit margins does appear to be at risk. And as Barclays’ Jonathan Glionna wrote in a note to clients earlier this month, the “link between profit margins and recessions is strong.”
As with the decline in earnings, however, the recent downtick in profitability is also greatly affected by the energy sector. Looking at S&P 500 profits weighted by revenues, profit margins are still holding up well.
And so this broadly supports Sløk’s view that while energy is putting numerous corporate measures under pressure, the risks of a broad economic recession aren’t quite what you might think.