Forget about the stock market making historic highs, pay attention to profits.
Several money managers, some of whom say there may be a recession in 2020, are worried that profits levels are declining.
Profits, the lifeblood of an expanding economy and a booming stock market, are starting to run down, they note. Declining profits are often a warning sign that a recession, a bear market or other bad things could be near.
Weak earnings, says Richard Bernstein of Richard Bernstein Advisors, is the most important factor in the economy. “When corporate profits turn negative, corporations tend to lay people off,” he says.
Bernstein added “earnings are now much more important because corporate profits are now much weaker than the overall economy.” He added investors should also be concerned.
“You’ve never had a bear market that didn’t occur within six months of a profit recession,” Bernstein recently wrote in a report.
Several market observers put the chance of a recession next year at about “fifty percent.”
“We think the recession risk has been rising over the course of this year,” according to Jeffrey Schulze, investment strategist at ClearBridge Investments. His comments came at the recent Legg Mason 2020 outlook. Now, he added, the economy leans toward recession.
Schulze looks at key economic indices. These include financial stresses, retail sales, jobless claims and inflation. They, along with profit margins starting to decline, show the economy is leaning toward recession.
The data often leads to a recession six to nine months afterwards, Schulze said. “We do think there will be a recession scare sometime in the first quarter or second quarter of next year,” he adds.
Another money manager slightly disagreed with Schulze.
“I think you are underestimating it (the recession potential). I think it is more than 50/50,” said Kim Catechis, head of investment strategy at Martin Currie. “I think you are likely underestimating the damage done on corporate profitability. It is underreported.”
Still, Schulze added, while there is “a rising recession risk” it doesn’t guarantee one. He said several times over the past twenty years the economy was primed for recession, but the Fed saved the day with interest rate cuts.
Nevertheless, U.S. companies were recently still beating earnings expectations but by smaller than previous margins, according Refinitiv IBES Data. And earnings margins, it added are also expected to decline early next year.
That, Bernstein says, could have a domino effect.
If soft earnings lead to corporate layoffs, he says, that could spook the consumer. Big consumer spending has been a prominent factor in the recent economic expansion.
“If layoffs go up,” Bernstein asks, “will that lead consumers to retrench out of fear?”