Monday, 10 December 2007

S&P500 4Q07 Earnings Expectations Turn Negative

As at Dec 5th 98% of S&P500 companies have reported 3Q07 earnings with year over year quarterly earnings showing a decline of -9.5%. The Sep 2007 quarter is the first quarter to record a year over year earnings decline since the Dec 2001 quarter.

At the same time earnings estimates for 4Q07 are now negative on a year over over year basis. About a month ago expectations were for a double digit increase, now the estimate is for a -1.6% decline from the 4Q06. Analysts have started to get more realistic about earnings, particularly for the large brokers and other financials.

The graph above shows that there have been 3 periods prior to 3Q07 when S&P operating earnings turned negative in the last 18 years. The first one and most prolonged started in September 3Q89 and lasted until 4Q91 with a brief return to positive earning in the 3Q90. What else happened around this period? Oh yes there was a recession.

The other prolonged period of negative earnings lasted from 4Q00 - 4Q01. What else happened around the same time? That's right you guess it, a recession. The only other time earnings turned negative was in 3Q98, when quarterly earnings showed a -5.3% dip. Of course there was no recession at that time. It took two more years for the tech bubble to burst.

I've been saying for about 6 months that the US earnings cycle was on it's last legs. No doubt as we get closer to 4Q07 reporting season earnings estimates will continue to come down. Merrill Lynch came out with a note a couple of weeks ago announcing that 'the earnings recession is here,' and as detailed above earnings recessions usually arrive with economic recessions not far behind.

Remember most analysts do not see a recession and are therefore arguing for a mid-cycle economic slowdown such as that seen in 1996. However S&P500 earnings are suggesting this will be more than just a mid-cycle slowdown. I suspect stock prices to follow in short order.