In the previous post, I examined the relationship between the economy and corporate earnings and showed that we should be sceptical about the numbers reported by companies as “earnings”. Profits, as measured by the national accounts data, not only suggest profits might be 30% lower than companies represent them to be but that they have also been declining for the past few years, rather than ever rising to record highs in the earnings series.
In this post, I will leave aside scepticism on historic reported earnings, and instead examine the impact of the recession on earnings and what we should make of current earnings forecasts. The chart below shows GAAP earnings as a percentage of sales, including the current forecasts to 2021.
Looking at the last two recessions, we see what we would normally expect. Profits and profitability hit hard, taking about 4 years to return to the levels before the recession. The depth of these earnings recessions corresponds to the depth of the economic recessions, with 2008 being much deeper than the recession of 2001.
If we look at the current recession, the market professionals who forecast earnings and the economy are expecting a completely different outcome. Despite this economic recession being far deeper than that of 2008, in fact the deepest since the Great Depression of a century ago, earnings are not expected to fall far. In addition, they are not just expected to quickly recover to the historic average of around 8%, but back up record high levels of profitability of over 10% before the end of 2021.
Have US companies disconnected from the real economy?
The chart above suggests that the drop in profits so far is entirely consistent with what we would expect in a recession. However the forecasts for profits to return to previous highs within 2 years do not tie up with examining previous recessions. These suggest a much longer recovery of 4 years but also that the current fall in profits may not be over.