As Earnings Outlook Darkens, Recession-Talk Begins

By David Berman

A lot of observers are sounding increasingly optimistic about the global economy. The problem is that corporate managers aren't among these optimists, and that could be a problem as we head into first-quarter earnings season.

One way of gauging the corporate view is to look at how managers have been guiding earnings. During good times, they tend to revise their earnings guidance higher, meaning they give themselves ambitious targets for their quarterly results, and markets cheer.

These don't appear to be good times right now, though. Indeed, the folks at Brockhouse Cooper believe that the shrinking number of upward revisions and the rising number of downward revisions is consistent with a recession.

"The fact that company managers are not guiding the market higher tells us that their outlook is not as rosy as the market thinks," said Pierre Lapointe, Alex Bellefleur and Frances Donald, in a note.

According to their numbers, 462 U.S. companies have guided their earnings lower over the past three months versus just 181 companies that have guided their earnings higher, which is a decade low for the latter number. Put the two figures together and you get a ratio of about 2.6, which Brockhouse Cooper argues is a level only seen in recessions.

This follows a so-so earnings season in the fourth quarter, particularly when looked at from the perspective of how many companies managed to beat expectations: Just 62.2 per cent did it. That might sound okay, but historically it is quite low.

There are some concerns that companies might have trouble boosting earnings now that most of the typical boosters - cost-cutting, for example - have been accomplished. Sky-high profit margins are likely going to come down as well, also weighing on earnings.

"Consequently, the equity rally that we have seen since the beginning of the year might come under pressure over the next few weeks," Brockhouse Cooper said.

They're not alone in their concerns. Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America, pointed out that earnings revisions from analysts and earnings guidance from management are diverging - with the mood among analysts rising recently even as the mood among managers grows darker.

"The last time revisions and guidance diverged as they are today, we saw a spate of downward earnings-per-share revisions shortly follow suit," she said in a note.

In other words, it pays to heed warnings from management.

Disclosure: None