Corporate profits are tanking.
For yet another quarter, American companies have taken a hit on their bottom lines.
And while a drop in corporate profits hasn’t yet led to a broad economic slowdown, history says that it is only a matter of time until we’re in recession.
Unless something drastic happens.
Since 1900 there have been 27 instances of two straight quarters of EPS decline, similar to what we have now, according to Dubravko Lakos-Bujas at JP Morgan.
And in most cases this forecasts doom for the economy.
“Declining corporate profits as measured by US equity EPS have been closely followed by, or coincided with, a recession 81% of the time since 1900,” Lakos-Bujas wrote in a note to clients this week.
And given where the profit cycle is, Lakos-Bujas said that history says only an outside economic shock has been able to keep the economy out of recession.
“The remaining 19% of slumps were followed by a re-acceleration of growth to a higher peak before recession inevitably ended the cycle — though not without some form of stimulus (fiscal, monetary or exogenous),” Lakos-Bujas said.
Historically speaking, the only way for the US to truly kickstart economic growth at this point is some sort of demand stimulus.
Here’s a quick rundown from Lakos-Bujas on each of those five exceptions:
- 1930s: FDR’s Second New Deal, Work Progress Administration, expansion of the money supply
- 1940s: Ramp-up in wartime industrial production (WWII), expansion of Fed balance sheet
- 1960s: Vietnam War deficit spending, Tax Reduction Act, falling oil prices, Fed monetary easing
- 1980s: Falling dollar (Plaza Accord), falling oil prices, Fed monetary easing
- 1990s: Dot-Com boom (rapid productivity gains, wealth effect from surging stock market), Fed monetary easing
So to recap, that’s two large-scale government spending sprees due to a war (not preferable), two major Fed easing cycles accompanied by another market-based tailwind, and one of the largest domestic fiscal stimulus programs in US history.
The issue is any sort of large scale stimulus package would have to come from the government, and as Raman Srivastava of BNY Mellon’s Standish Asset Management told Business Insider that is just not going to happen.
“Look at the US, we’re in the middle of an election year, there’s not going to be an announcement of a giant stimulus package in this environment,” said Srivastava. “We would really need something economically dramatic to happen before stimulus became possible.”
So the economy is stuck between a rock and a hard place.
History says that in the current profit decline, the only thing that can keep the economy out of recession is stimulus or the Fed cutting rates.
But with the Fed embarking on rate hikes not cuts, according to Srivastava the only thing that could get the government to step in would be a recession-like event.
As we’ve noted before, many analysts don’t think slowing profits point to a recession, but merely reflect the temporary impact of low energy prices and a strong dollar.
Bullish economists point to higher consumer spending, wage growth, and a strong labour market to make the case that this is merely a temporary affliction for American corporates.
But when predicting the future of the economy, the only guide you have is the past.
And in this instance history isn’t saying anything good.
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