Cloudy earnings outlook divides analysts

Third-quarter earnings season begins next month and analysts are divided as to what’s in store.

The positive take is that recession talk is overstated. Ritholtz Wealth Management’s Michael Batnick notes 75 per cent of companies beat second-quarter estimates and profits grew 6.3 per cent. “This looks nothing like a recession,” says Batnick, “where the average decline in earnings is 21.3 per cent.”

However, there are clouds. FactSet data shows 240 companies cited recession in earnings conference calls – more than four times the five-year average and the highest number since 2010.

Earnings estimates are also coming down. That’s normal before earnings season, but both FactSet and Credit Suisse note recent cuts are sharper than usual. Still, given stocks have already cratered, recent revisions are “a far cry from the punch in the gut many feared”, says SoFi’s Liz Young.

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Earnings declines during a recession can vary – some are shallow (-4.6 per cent in 1980), some severe (-91.9 per cent in 2007-09), so there is no “magic level”. Still, estimates would need to come down “markedly” from current levels to become a recession signal, she says.

Bearish Morgan Stanley strategist Mike Wilson says those big cuts are coming, saying we will soon see “some of the most significant downward revisions” to earnings forecasts seen in the past several cycles. Wilson’s estimates are among the most bearish on Wall Street, and opposing voices point to robust profit margins and the fact revenues tend to go up along with inflation.

Forecasting the earnings outlook in a volatile economic climate is tricky. Next month’s earnings should shed light as to whether a profits recession can be averted.