CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
US English

Earnings recession explained: Everything you need to know

By Fitri Wulandari

Edited by Jekaterina Drozdovica

16:07, 24 June 2022

Earnings recession explained: Everything you need to know recession, thousand rupiah macro coins, macro coins, coins scattered and in the middle it says
Earnings recession explained: Everything you need to know Photo: ImageFlow / Shutterstock.com

In May, Snap (SNAP) announced that it was likely to miss its revenue and EBITDA targets for the second quarter after disappointing first-quarter results. The US-based operator of instant messaging application Snapchat blamed the deteriorating macroeconomic environment, including rising inflation, for its gloomy earnings outlook.

Snap is not the only company missing its earnings estimates and revising targets. Meta (META), Facebook’s parent company, missed its first-quarter earnings expectations. Google’s parent company Alphabet (GOOGL) reported in April that its earnings were lower than predicted and growth in its YouTube business slowed significantly compared to last year.

In May, retail giants Walmart (WMT) and Target (TGT) reported that their first-quarter earnings fell short of expectations, citing rising costs and persistent supply chain issues. 

Are companies entering an earnings recession, and how can investors protect themselves from the downturns? Here we take a look at what is an earnings recession and whether it’s coming in the next earnings season. 

Earnings recession explained

Earnings recession is defined as a period when corporate profits are down from a year ago for two consecutive quarters. An earnings recession typically occurs during an economic slowdown or economic recession

The US National Bureau of Economic Research (NBER) defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real Gross Domestic Product (GDP), real income, employment, industrial production, and wholesale-retail sales.” 

 

A recession begins just after the economy hit a peak of activity and ends as the economy reaches its trough, according to the bureau. 

Recession is typically marked with reduced output and surging unemployment as companies or government offices reduce workers to cut costs. Based on NBER data, there have been 10 periods of recession in the US since 1957.

Recessions are often driven by a combination of variables such as high interest rates and poor consumer confidence.

Risks of recession in the US currently stem from the US Federal Reserve’s (Fed) aggressive tightening of monetary policy to tame four-decades high inflation. US inflation accelerated to 8.6% in May, the highest increase since December 1981, the Bureau of Labor Statistics announced on 10 June. The country’s inflation in April stood at 8.3%.

The Fed responded to rising inflation with a 0.75 percentage point rate hike on 15 June – the biggest increase since 1994.  While acknowledging the rise was an “unusually large one”, Fed chairman Jerome Powell suggested a further 50 or 75 basis point increase is possible at the Fed’s next meeting in July.  

The Fed’s policy of raising interest rates to slow economic growth and lower inflation heightened risks of economic contraction. Corporate earnings depend on economic growth – as the economic activity slows and borrowing costs increase, a company’s earnings may deteriorate, causing an earnings recession. 

“The US economy is entering a period of slowdown as monetary policy tightening attempts to curb demand in response to excessively high inflation. The Federal Reserve is compelled to raise interest rates to restrictive levels, leading to a decrease in investment and consumption,” said Capital.com’s market analyst Piero Cingari. 

First-quarter earnings recap

The US benchmark S&P 500 (US500) index recorded an earnings growth rate of 9% in the first quarter of 2022, the lowest percentage since the fourth quarter of 2020, according to Facset’s data.

As many as 68 companies in the index gave negative earnings per share (EPS) guidance, which was the highest number since Q4 2019.

Of the 11 sectors in the index, energy posted the highest earning growth of 268%. Energy companies have benefited from rallying oil and gas prices since the last quarter of 2021 because supply was unable to keep up with the rebounding demand as countries lifted Covid-19 restrictions. 

The war between Russia and Ukraine has fuelled the energy prices rally as Western nations imposed sanctions to target Russia’s oil exports. In the first quarter, the international benchmark Brent crude gained more than 38% after briefly crossing $139 a barrel on 7 March. 

Inflation was the main concern in the first quarter. The term “inflation” was mentioned at least once during the earnings calls of 398 companies on the index between 15 March to 24 May. 

In terms of the EPS growth, the S&P 500 recorded a blended rate of 4.4% for the first quarter year-over-year (YoY), according to S&P Global’s data. Energy had the highest growth at 225.9%, followed by consumer discretionary and materials at 45.2% and 33.4%, respectively. Communication services suffered the lowest negative growth of -5.7% year-on-year.

S&P 500 year-on-year earnings per share growth in Q1 2022

ETH/USD

3,344.71 Price
-4.060% 1D Chg, %
Long position overnight fee -0.0616%
Short position overnight fee 0.0137%
Overnight fee time 21:00 (UTC)
Spread 6.00

BTC/USD

65,626.85 Price
-0.260% 1D Chg, %
Long position overnight fee -0.0616%
Short position overnight fee 0.0137%
Overnight fee time 21:00 (UTC)
Spread 106.00

US100

19,107.30 Price
-3.380% 1D Chg, %
Long position overnight fee -0.0263%
Short position overnight fee 0.0041%
Overnight fee time 21:00 (UTC)
Spread 7.0

Gold

2,397.43 Price
-0.520% 1D Chg, %
Long position overnight fee -0.0193%
Short position overnight fee 0.0111%
Overnight fee time 21:00 (UTC)
Spread 0.60

What to expect from the next earnings season

With the Fed set to continue with rate hikes, what does the next earnings season have in store?

Capital.com’s Cingari said profit margin decreases may be a warning sign for forthcoming corporate earnings seasons, as rising input prices and decreasing revenues harm US companies’ profitability.

Investment research firm Zacks forecast total S&P 500 earnings to rise by 2.1% in the second quarter of 2022 from the same period last year. But without a hefty contribution from the energy sector, index earnings in the second quarter are expected to fall by -5.2%. 

“Part of the uncertainty in the market at present is related to how earnings estimates should evolve in an aggressive Fed tightening cycle. The market has a sense of what should happen to earnings estimates, but it isn’t seeing much of that just yet,” Zacks’s director of research Sheraz Mian wrote in the note on 22 June.

For the full calendar year, Zacks estimated total S&P earnings to rise by 8.9% in 2022 and 9.0% in 2023. If earnings from the energy sector are not taken into account, the index’s earnings in 2022 would grow by only 3.6%.

Facset forecast S&P 500 companies to report annual earnings growth rate of 4.3% in the second quarter, lower than the 5.9% estimated on 31 March, according to a note published on 17 June.  

The downward forecast revision was due to more companies issuing negative EPS guidance and net downward revisions to earnings estimates. If 4.3% is actual growth, it will be the lowest earnings reported by the index since the fourth quarter of 2020. 

For the third and fourth quarters, Facset analysts forecast earnings growth of 10.7% and 10.1%, respectively, while full-year earnings growth was expected at 10.4%. 

Capital Economics also suggested the possibility of disappointing S&P 500 earnings growth due to tightening monetary policy.

“Our new forecasts for tighter monetary policy probably mean US economic activity – and therefore corporate earnings growth – will be a bit weaker than we had previously anticipated,” they said in a note on 17 June. 

“Corporate earnings surveys have consistently painted a picture that we think is too rosy as the outlook for the economy has dimmed…The prospect of disappointment on earnings means that we think the equity market may continue to struggle even once yields have reached their peak.”

Capital Economics forecast the S&P 500 to fall from 24 June level of 3,700 to 3,400 by the end of this year, and to 3,200 by end-2023. After that, they suggested, the index could recover, reaching 3,600 by end-2024. 

Note that analysts’ predictions can be wrong. Forecasts shouldn’t be used as substitutes for your own research. Always conduct your own diligence and remember that your decision to trade or invest should depend on your risk tolerance, expertise in the market, portfolio size and goals. 

Keep in mind that past performance doesn’t guarantee future returns. And never invest or trade money you cannot afford to lose.

How to prepare for an earnings recession

“Investors should watch for how the stock price reacts to worse than expected earnings.”
by David Jones, chief market strategist, Capital.com

David Jones, Capital.com’s chief marketing strategist said an earnings recession does not have to be necessarily bad and should have been already expected by investors, given the slowdown in the global economy amid high inflation and rising interest rates. 

“It has been no secret that times have been tougher for many companies. So one thing that investors should watch for is how the stock price reacts to worse than expected earnings,” Jones said.

“If a stock price was to rally on weak earnings, it could be a sign that the market has already factored the bad news into the price. Markets are always looking forward and weaker earnings are going to be no surprise - it could actually provide some interesting opportunities for investors where on some stocks at least, stronger performance after weaker earnings could be the sign that sentiment is finally starting to change.”

Capital.com’s Cingari pointed out that pricing power – a company's ability to increase product or service prices without losing demand - could be a key factor to watch out for when selecting stocks during the current period of earnings recession. Income stocks that pay higher dividend yields could also be an option to consider. 

“Historically, companies with pricing power could adjust their prices to keep up with inflation, minimising the impact on their profitability. Companies that consistently pay dividends may see interest during downturn periods,” he said. 

In terms of sectors, utilities and healthcare may fit these criteria, while cyclical sectors such as energy and financials may suffer during slowdowns. “Although the former might still enjoy windfall gains if oil prices don’t fall substantially,” he added.

FAQs

What to invest in during a recession?

According to Capital.com’s analyst Piero Cingari, companies with higher pricing power and those that consistently pay dividends, such as utilities and healthcare stocks, may outperform during the downturn. Note that analyst predictions can be wrong. Forecasts shouldn’t be used as a substitute for your own research. Keep in mind that past performance doesn’t guarantee future returns. And never invest or trade money you cannot afford to lose.

How often does recession happen?

According to data from the US National Bureau of Economic Research (NBER), there have been 10 recession periods in the US since 1957. Each recession period lasted for an average of 13 months, according to calculation by Jefferies.

How do recessions affect the economy?

Rising unemployment is one of the key consequences of a recession. It is most common among low-skilled workers, as they are generally the first to go when corporations or government agencies lay off staff to cut expenses. Increased unemployment could force the government to expand government-funded relief programmes to assist families affected by layoffs in making ends meet. Another effect of the recession is that more businesses could collapse and production falls.

Markets in this article

GOOGL
Alphabet Inc - A (Extended Hours)
172.80 USD
-9.87 -5.410%
META
Meta Platforms Inc (Extended Hours)
464.05 USD
-22.1 -4.550%
SNAP
Snap Inc (Extended Hours)
13.71 USD
-0.53 -3.770%
US500
US 500
5441.4 USD
-117.3 -2.110%
TGT
Target
146.57 USD
-3.9 -2.600%

Rate this article

The difference between trading assets and CFDs
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.
Capital Com is an execution-only service provider. The material provided in this article is for information purposes only and should not be understood as investment advice. Any opinion that may be provided on this page does not constitute a recommendation by Capital Com or its agents and has not been prepared in accordance with the legal requirements designed to promote investment research independence. While the information in this communication, or on which this communication is based, has been obtained from sources that Capital.com believes to be reliable and accurate, it has not undergone independent verification. No representation or warranty, whether expressed or implied, is made as to the accuracy or completeness of any information obtained from third parties. If you rely on the information on this page, then you do so entirely at your own risk.

Still looking for a broker you can trust?

Join the 630,000+ traders worldwide that chose to trade with Capital.com

1. Create & verify your account 2. Make your first deposit 3. You’re all set. Start trading