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Preparing for a Recession – In Profits

Now that the obsession with the Fed has likely subsided for a bit, the U.S. equity markets may have a new worry to contend with: Earnings growth. S&P Capital IQ consensus EPS estimates for the S&P 500 continue to slide for 2015, now registering only 0.3% growth as compared with a high single-digit growth forecast just a few short months ago. While not an official profit recession, as no contraction in EPS growth is currently projected, the full-year growth estimate is getting uncomfortably close to that threshold. And like the recognizable pair of Astaire and Rogers, downward EPS growth trends and economic recessions also go hand-in-hand. Since 1945, all 10 recessions were accompanied or preceded by downward trending growth in rolling 12-month EPS for the S&P 500 (using GAAP earnings from 1945 through 1989 and operating results thereafter), and only three times did we experience a decline in EPS growth that did not result in a recession. These “profit recessions” bottomed in Q4 1967 and Q4 1985 with year-over-year EPS declines and in Q4 1998 with only 0.6% growth.

Annual EPS Growth Trends and Recessions 1945-2015

This time around, while 2015 is projected to deliver sub-1.0% growth in 12-month operating EPS, accompanied by less-than 2% growth for Consumer Staples and Utilities, Energy appears to be the sole reason for this anemic growth expectation, due to its projected 56% shortfall. At least during the last profit recession in 1998, four sectors recorded year-over-year declines in operating EPS, led once again by a near-45% decline in Energy’s profits. In addition, it was accompanied by red ink for the Information Technology, Materials and Telecom Services sectors.

So there you have it. The Fed’s new-found dovishness has propelled stocks once again. But to what heights? And with the Q1 2015 EPS reporting season soon to be upon us, investors will need to decide if the precipitous decline in 2015 EPS growth estimate foretells the approach of an overall recession, or merely a slowing of the profit sprint, as a result of running out of Energy.

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