US equity earnings are behaving similarly to the run-up to previous recessions, tallying with multiple leading indicators showing the US is on track for an economic slump.
Earnings season gathers paces next week, with the big US banks announcing results. Earnings growth has slowed sharply in recent months as the economy feels the impact of higher rates. The ISM, global exports and earnings surprises all give reliable leading relationships for S&P earnings growth, and all point to weakness in coming months.
If we do get a recession, then the deceleration in earnings will intensify. Profit margins and P/E multiples are already a net drag for equity returns.
Unfortunately earnings, and earnings expectations, by themselves won’t help you gauge whether a recession is on the way, as both tend to lag the cycle. But if you combine them with other leading data, the case for a recession becomes much stronger.
Recessions are regime shifts and tend to happen quickly or not at all. That’s why economists often miss them. No one indicator is 100% reliable, but any high-quality ones will exhibit this regime-shift behaviour. One such is the Philadelphia Fed State Coincident Diffusion Index. It has currently dropped to a level that is only seen prior to recessions.
