Corporate America is entering a profit recession.
In the third quarter, earnings are expected to decline 5.1%, according to FactSet.
And following 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.
Weighing on corporate profits are declines in the energy sector due to the crash in oil prices, as well as a decline in revenue due to 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 of economic recessions.
But with the service sector of the economy still growing at a solid pace, Deutsche Bank’s Torsten Sløk — among others — does not think 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 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,” Sløk wrote.
“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.”
In his email, Sløk added that while earnings are declining, corporate profits are still 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 that the, “link between profit margins and recessions is strong.”
Though like the decline in earnings, the recent downtick in profitability is also greatly impacted 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 a number of corporate measures under pressure, the risks of a broad economic recession aren’t quite what you might think.