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What will an earnings recession do to stocks?

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Summary:
Earnings season is just around the quarter, and earnings growth is expected to be negative. Many traders have attributed the stock market’s rally over the past few months to a dovish Fed. Today’s headlines: Earnings growth Goldman Sachs Bull/Bear Indicator Large caps outperforming small caps Industrials underperformance Fed’s dovishness Go here to understand our fundamentals-driven long term outlook. For reference, here’s the random probability of the U.S. stock market going up on any given day. Earnings growth Q2 earnings season is just around the corner. According to Factset, this could be the 2nd consecutive quarter that saw a year-over-year decline in earnings. The decline in earnings growth raises the risk of an “earnings recession”. *Corporate earnings and the stock

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Earnings season is just around the quarter, and earnings growth is expected to be negative. Many traders have attributed the stock market’s rally over the past few months to a dovish Fed. Today’s headlines:

  1. Earnings growth
  2. Goldman Sachs Bull/Bear Indicator
  3. Large caps outperforming small caps
  4. Industrials underperformance
  5. Fed’s dovishness

Go here to understand our fundamentals-driven long term outlook. For reference, here’s the random probability of the U.S. stock market going up on any given day.

What will an earnings recession do to stocks?

Earnings growth

Q2 earnings season is just around the corner. According to Factset, this could be the 2nd consecutive quarter that saw a year-over-year decline in earnings. The decline in earnings growth raises the risk of an “earnings recession”.

*Corporate earnings and the stock market move in the same direction in the long term.

What will an earnings recession do to stocks?

Here’s what happened next to the S&P when earnings growth fell for 2 consecutive quarters.

What will an earnings recession do to stocks?

What will an earnings recession do to stocks?

This is a risk for the stock market over the next 3-9 months. With the exception of 2012, the historical cases were all followed by a 15%+ decline within the next few months.

Here’s Q2 2015:

What will an earnings recession do to stocks?

Here’s Q1 2008:

What will an earnings recession do to stocks?

Here’s Q2 2001:

What will an earnings recession do to stocks?

Here’s Q2 1998:

What will an earnings recession do to stocks?

Q1 1990:

What will an earnings recession do to stocks?

Goldman Sachs Bull/Bear Indicator

Goldman Sachs has a widely quoted Bull/Bear Indicator that takes the average percentile of 5 indicators:

  1. ISM
  2. Yield curve
  3. Core inflation
  4. Unemployment
  5. Shiller P/E

This indicator is starting to roll over because Shiller P/E, ISM, and core inflation are falling.

What will an earnings recession do to stocks?

What will an earnings recession do to stocks?

A high Bull/Bear Indicator doesn’t mean much, because like the Shiller P/E ratio, there’s no guarantee that it will peak until it has already peaked. (The same way how “overvalued” can become even more overvalued).

That’s why it’s better to look at when the Bull/Bear Indicator peaks and starts to roll over. The Goldman Bull/Bear Indicator is rolling over right now.

What will an earnings recession do to stocks?

While popular, comparing today vs. 2000 and 2007 makes no sense. N=2 and recency bias.

So here’s every case in which the Bull/Bear Indicator’s 1 year rate-of-change turned negative for 2 consecutive months.

What will an earnings recession do to stocks?

*The most recent reading uses economic data from May 2019, which was released throughout June 2019.

You can see that while this doesn’t always mark the bull market’s exact top, it certainly is late-cycle. Hence why the long term returns are worse than random.

What will an earnings recession do to stocks?

Large caps vs. small caps

Large caps (S&P 500) continue to outperform small caps (Russell 2000), which is why the S&P:Russell ratio continues to trend upwards.

What will an earnings recession do to stocks?

The S&P:Russell ratio has been above its 200 dma for 197 consecutive days, which is quite a long streak of large cap outperformance.

What will an earnings recession do to stocks?

Large caps outperformance isn’t consistently bullish or consistently bearish for the S&P and Russell….

What will an earnings recession do to stocks?

What will an earnings recession do to stocks?

…. and while it’s easy to assume that small caps will “catch up”, this isn’t always the case. Moreoften than not, large caps continue to outperform, thereby pushing the S&P:Russell ratio even higher.

What will an earnings recession do to stocks?

Industrials

Industrials (XLI) have lagged the S&P recently, causing the XLI:S&P ratio to fall.

What will an earnings recession do to stocks?

What will an earnings recession do to stocks?

This is not consistently bullish or bearish for the S&P…

What will an earnings recession do to stocks?

But is mostly bullish for XLI over the next year….

What will an earnings recession do to stocks?

…Which is why the XLI:S&P ratio tends to rise 9 months later.

What will an earnings recession do to stocks?

Fed’s dovishness

And lastly, Nordea has a chart which demonstrates that the Fed is extremely dovish right now – almost as dovish as during the 2002 and 2009 stock market bottoms. Personally, I don’t think comparing today to 2002/2009 makes sense. 2002/2009 occurred after a massive 50%+ bear market + recession. The economy and stock market today are in the late-stages of a bull market and economic expansion.

What will an earnings recession do to stocks?

We don’t use our discretionary outlook for trading. We use our quantitative trading models because they are end-to-end systems that tell you how to trade ALL THE TIME, even when our discretionary outlook is mixed. Members can see our model’s latest trades here updated in real-time.

Conclusion

Here is our discretionary market outlook:

  1. Long term: risk:reward is not bullish. In a most optimistic scenario, the bull market probably has 1 year left.
  2. Medium term (next 6-9 months): most market studies are bullish.
  3. Short term (next 1-3 months) market studies are mixed.
  4. We focus on the medium-long term.

Goldman Sachs’ Bull/Bear Indicator demonstrates that risk:reward favors long term bears.

What will an earnings recession do to stocks?

Click here for more market analysis

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