This column is not about where that economic recession remains, but about an earnings recession that has passed. At least, if my global profit indicator is to be believed.
A global profit indicator
Profits are largely cyclical and so you should be able to describe them reasonably well with a set of «good» cyclical macro indicators. And that turns out to be the case. My ‹bellwether EPS indicator› predicts the change in the year-on-year earnings-per-share of the MSCI World Index using the following macro indicators:
- Global semiconductor sales
- Singapore electronics exports
- South Korean exports
- Chinese producer prices
The first three indicators have the common denominator that they are particularly sensitive to the global economic cycle. They are sales of cyclical goods (semiconductors) and exports from very open economies. Chinese producer prices reflect the degree of overcapacity in the world’s second largest economy. More overcapacity, read falling producer prices, is obviously not good for earnings growth.
The logical question raised by these four profit forecasters is whether they are not all measuring the same thing. But they don’t. When I run a simple regression with the four macro indicators as explanatory variables, all four come out statistically significant.
Profit magic?
The chart below shows that the bellwether EPS indicator is a more than reasonable predictor of earnings trends globally. But not for a while recently.
In the second quarter of 2023 (the indicator forecasts between two and six months ahead), the earnings indicator pointed to an earnings decline of more than 20 per cent. But as the chart shows, earnings growth has been positive to this day. Moreover, all four underlying indicators have since recovered sharply and now point to positive earnings growth of 4 per cent.
This time it’s different
Globally, realised earnings replicate the global economy. Numerous familiar macro indicators such as the yield curve, property investment, and housing market activity pointed, or still point, to an economic recession. And while the probability of a recession is certainly not zero, it has diminished considerably. I am not a fan of it, but a bit of «this time is different» seems appropriate here.
What could explain the lack of earnings recession? First and foremost, of course, is that we have not seen an economic recession. Indeed, growth in the US has actually been much higher than expected. With the caveat that this is largely artificial due to incessant fiscal stimulus. Something that will have a tailspin, if you ask me.
Catch-up effects due to supply chain disruptions also play a role. And also the ‹pricing power› of companies, which is still enormous, has prevented profits from going head-to-head even during a period of high wage growth. Moreover, many companies are a lot smarter than the US government by rolling over their debt for a long time, limiting the impact of higher interest rates for now. Finally, companies have built up historically high cash reserves that carry solid interest income.
Start of the cycle?
As mentioned, we should not underestimate the chances of a recession. But the bellwether EPS indicator is just one of a growing number of variables indicating that we are right at the beginning of the economic cycle. And if I then think back for a moment to those two quarters of negative growth in America in the first half of 2022, it may just be that a recession was not prevented, but simply forgotten (by the NBER) to write it down.
Jeroen Blokland is founder and manager of the Blokland Smart Multi-Asset Fund and founder of True Insights, a platform providing independent multi-asset investment research. Blokland was previously head of multi-assets at Robeco. His chart of the week appears every Thursday on Investment Officer.