U.S. corporations made too much money last year...
Our economy has spent much of 2022 digesting inflationary pressures. And the effects have started to show in recent quarterly earnings.
As I discussed in yesterday's essay, big banks Morgan Stanley (MS) and Goldman Sachs (GS) are concerned that we're on our way to an "earnings recession." That happens when corporate earnings fall for two consecutive quarters.
As the full picture for second-quarter earnings becomes clearer, other outlets have started to echo this sentiment. But being in an earnings recession doesn't mean that our economy is in an actual recession.
To understand why, you have to consider the factors that could lead to this drop in earnings. It's at least partially due to the Fed raising rates as it looks to cool down the economy and slow inflation.
But there's another key reason for this downtrend. As Morgan Stanley explained, companies over-earned in 2021.
This over-earning was a result of government stimulus packages and a historic rise in consumer demand. This situation is very similar to what happened in 1945...
As the world recovered from World War II, soldiers returned home and started families. Demand for consumer goods skyrocketed, pushing corporate America's operations to unsustainable levels.
Gross domestic product ("GDP") in 1946 surpassed what should have been possible. So it made sense when earnings fell back to normal levels in the following years.
We've been experiencing the same thing today due to rising demand following the pandemic.
The Fed is trying to slow this demand in the hopes that inflation will follow suit. While this is in the economy's best interest, it will hurt near-term company earnings.
Tightening financial conditions have discouraged consumer spending and corporate borrowing.
Many economists argue higher costs for raw materials and rising wages are cutting into corporate profits. This will bring corporate earnings back to longer-run averages as a share of GDP.
It looks like after 2021's unsustainably high earnings, things are beginning to fall back to Earth.
The situation should all even out in the end...
At the start of the year, as-reported trailing 12-month ("TTM") earnings per share ("EPS") for the S&P 500 barely grew. That number rose a paltry $0.04, from $197.87 in the fourth quarter of 2021 to $197.91 in the first quarter of 2022. That's only 0.02% higher.
But that hasn't been the case for the second quarter.
More than 99% of companies have reported second-quarter earnings. Earnings dropped almost 3% quarter over quarter, down to $192.32.
This is the first S&P 500 earnings dip in the past six quarters... since the midst of the pandemic.
And third-quarter estimates don't look any better. Earnings are forecast to drop another 0.5% to $191.25. Wall Street analysis expects this decline to continue through the end of the year, bottoming at $188.20 before recovering in the first quarter of 2023.
Operating earnings – earnings excluding write-offs from management – paint a somewhat rosier picture. While they also show a drop in the second quarter, they're forecast to rebound sooner than EPS.
With earnings looking rudderless, many are concerned about what it means for the market...
But that's not what you should be focused on. It doesn't matter whether market earnings return to growth this quarter or next year.
Even when overall corporate earnings show weakness, that doesn't mean every part of the economy is struggling.
The S&P 500's second-quarter dip was largely driven by declines in the consumer discretionary and financial sectors. TTM consumer discretionary earnings were down $3 in the second quarter of 2022. The financial sector's earnings have dropped a staggering $13 since the fourth quarter of 2021.
These two underachievers pushed the entire index down. But some pockets of the market were stronger... The energy sector's TTM earnings increased almost $20 from the first quarter of 2021. Health care earnings rose $2.
And even an uncertain market breeds opportunity...
It's hard not to focus on the direction of the market as a whole – especially when that's all the mainstream financial media can talk about.
And yet, whether you're investing in an up market... a down market... or a sideways market... there's always a way to make money if you look in the right places.
In the face of so much volatility, it's vital to know where to look and what to look for. Together with Altimetry's corporate affiliate Chaikin Analytics, we think we've unlocked a one-of-a-kind recipe to find the best stocks for what the market is doing right now.
We spent months working with the Chaikin team. Together, we set out to understand how their award-winning stock-picking software (called the "Power Gauge") could combine with Altimetry's Altimeter software system to produce the best possible results...
We're calling them "Perfect Stocks." And we don't think that's an exaggeration.
When both of our systems flash green at the same time, it tells us a stock is primed to take off – no matter the market environment. Our criteria are so precise that only 133 stocks have ever earned the title of "Perfect." And the average Perfect Stock has beaten the S&P 500 by 4 times over the past decade.
In today's choppy, uncertain market, stocks like this could be a huge boon to any portfolio. That's why tonight, at 8 p.m. Eastern time, I'm hosting a special "Financial Lifeline" event with Chaikin Analytics founder Marc Chaikin to share what we've found.
During this world-premiere broadcast, we'll reveal the names and ticker symbols of two promising opportunities... as well as two widely held stocks that we believe could fall to zero in the coming weeks.
But that's not all...
If you sign up to attend right now, Marc and I will immediately send you free access to the easy-to-use "lite" version of our Perfect Stock Detector – so you can see how almost any company stacks up against our strict criteria.
Our 2022 Financial Lifeline Event is absolutely free to attend. All we ask is that you reserve your spot in advance right here. I hope to see you tonight.
September 22, 2022