#104 – The deeper the recession, the deeper the earnings decline will be. Even in China??

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#104 – The deeper the recession, the deeper the earnings decline will be. Even in China??

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 – In this article you’ll find:

  • Why economic growth will reflect inevitably on companies’ earnings
  • Earnings remain correlated to economic growth; earnings decline as rate hikes ensue
  • In China the scenario is more dovish and in 2023 the China’s economy should growth of 3.3%
  • Economic Recessions Leads to Earnings Recessions

Here you can find other articles:

  1. Bear Markets And Sectors Update
  2. From Disinflation To Inflation – Value Over Growth
  3. Is Entertainment & Media Industry Poised To Growth?

ENJOY THE ARTICLE

Introduction

As we’re entering in a new year 2023, the economic scenario is preparing for a suffering year and the outlook for the new year is not good.

In fact for the entire year, we should have no economic growth and a modest decrease in inflation rate.

As we know when we don’t have economic growth this will reflect inevitably on companies’s earnings.

In this research let’s will focus on the earning’s trend.

This trend has contained earnings growth since 1950. Currently, earnings estimates exceed that trend by one of the most significant deviations ever.

The only two previous periods with similar deviations are the Financial Crisis and the Dot.com bubble.

The deeper the recession, the deeper the earnings decline will be.

The whole point of the Fed hiking rates is to slow economic growth, thereby reducing inflation. As such, the risk of a recession rises as higher rates curtail economic activity. Unfortunately, with the economy slowing, additional tightening could exacerbate the risk of a recession.

Therein lies the risk. Since earnings remain correlated to economic growth, earnings decline as rate hikes ensue. Such is especially the case in more aggressive campaigns. Therefore, market prices have likely not discounted earnings enough to accommodate a further decline.

And finally, let’s even will see how this don’t impact enterally the Chinese market, which we are witnessing more dovish monetary policy than in the US.

We’ll touch how retail consumer spending in China is evolving over the years, remembering that in 2023 the China’s economy should growth of 3.3%.

 Monetary policy conditions index…

I love this chart, look it another time and another one. I really thank Real Investment Advice.

Is incredible how you can understand immediately how monetary conditions impact on S&P 500.

While the U.S. economy has absorbed tighter financial conditions so far, it doesn’t mean it will continue to do so. History is pretty clear about the outcomes of higher rates, combined with a surging dollar and inflationary pressures.”

The “monetary policy conditions index” measures the 2-year Treasury rate, which impacts short-term loans; the 10-year rate, which affects longer-term loans; inflation which impacts the consumer; and the dollar, which impacts foreign consumption. Historically, when the index has reached higher levels, it has preceded economic downturns, recessions, and bear markets.

Not surprisingly, the tighter monetary policy conditions become, the slower economic growth tends to be.

Monetary policy conditions index inverted – What happened?

While periods of high volatility eventually subside, the bearish period for stocks is ultimately tied to the monetary conditions present in the economy at the time.

If we invert our monetary conditions index and compare it to the annual changes in the price of the S&P 500 index, the correlation becomes apparent.

 This is not true for the Chinese markets, which we are witnessing more dovish monetary policy

The MSCI China Index is up 24% thus far in November, compared to just 2% for the S&P 500 Index.

This surge in Chinese stocks has propelled outperformance of emerging markets.

Yet, the potential reopening poses upside risk to inflation just as central banks appear to be stepping down their rate hikes.

Reflation risk

China’s reopening may be like most other countries’ reopening experiences, with economic growth accelerating (especially household consumption) and inflation picking up.

Any reopening beginning in March or April is likely to be gradual but could still lead to a surge in pent up spending in the world’s second largest economy.

1.4 billion consumers could lead to a rebound in global inflation for both commodities and goods.

It may come at just the point that central banks were pausing their rate hikes (see Central Banks Stepping Down for our thoughts on the end of rate hikes).

As China moves toward reopening, stocks seem to be welcoming the likely boost to global economic growth but may begin to worry over the potential need to extend rate hikes.

China consuming spending

Retail consumer spending fell -0.5% from a year ago in October 2022 compared with pre-pandemic growth of 7% in 2019 and a 10-year average growth rate of 12%.

Interestingly, for the first time in the event’s 14-year history, online giant Alibaba decided not to disclose sales results for Singles’ Day on November 11, the world’s biggest shopping day.

There may have been a number of reasons for this, but it may have been because the expected numbers wouldn’t be great and might bring even more focus on the zero-COVID measures holding back China’s economy.

Weak consumer spending alone may have contributed to a potential drag of 4-5% on China’s GDP for 2022.

The consensus of economists tracked by Bloomberg forecast China’s GDP growth to be 3.3% this year compared with 8.1% last year.

Economic Recessions Leads To Earnings Recessions

The estimated earnings for the S&P 500 companies remain highly elevated.

Such gives investors a false sense of security by assuming “forward valuations” suggest stocks are priced fairly.

In reality, many companies in the index remain overvalued despite the price decline in 2022.

More importantly, earnings have not accounted for a potential “hard landing” economically. In 2019, earnings declined by more than 30%.

Even the “soft landing” in 2015 saw earnings decline by more than 10% compared to current estimates.

 Important Considerations

Investors are dealing with a bearish market for the first time in over a decade. Such is something that many investors in the stock market today have never witnessed firsthand.

Nonetheless, it has been a challenging year on many fronts, given the enormous number of negative days and increases in daily volatility.

Join the conversation with your own take on these topics in the comments below.

About the Author

Alessandro is a Financial Markets enthusiastic and he loves learning from articles/papers on many financial topics.

In doing so he shares with you the most interesting charts and comments.

Disclosure

This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. 

It has been prepared for informational purposes only. 

Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

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