This one data point shows an earnings recession is still on the table

Scott Gamm

Brace for yet another quarter with negative earnings growth for S&P 500 (^GSPCcompanies.

That’s the assessment from FactSet, which expects a 2.5% decline in second quarter earnings, year-over-year, which follows the 0.3% drop seen for the first quarter.

Should the second quarter post any type of negative earnings growth, that would cement the first two quarters of back-to-back negative earnings growth since 2016. Analysts tend to characterize this phenomenon as an earnings recession.

One of the culprits for declining earnings expectations was a strengthening dollar driven by policy mistakes — whether from the Federal Reserve or trade tariffs, according to Brian Levitt, senior director, investment strategy at Invesco.

“Many U.S. companies are multinational,” he said, noting that that market was worried about a deteriorating earnings picture during the month of May, when the S&P 500 declined over 6%.

Federal Reserve vs. earnings

“With the Fed backing off, that has helped stabilize the dollar and should create a better backdrop for U.S. businesses,” Levitt added.

While most market participants aren’t expecting the Fed to announce a cut to interest rates at its policy meeting this week, the market is increasingly pricing in high probabilities of a cut at some point in 2019, perhaps as soon as July. In recent weeks, various Fed officials, including Chair Jerome Powell, have signaled their interest in maintaining the economic expansion.

The other factor keeping investors calm is the fact that the modest decline in first quarter earnings wasn’t supposed to be so modest. On March 31, towards the start of the first quarter reporting season, FactSet was expecting a 4% decline in first quarter earnings. This is leading some to believe a similar dynamic may take shape for second quarter’s results.

“I think the reason investors aren’t fretting about Q2’s projected decline is that EPS were forecast to fall 2.4% in Q1, yet rose 2.3%, marking the 29th consecutive quarter in which actual results exceeded end-of-quarter estimates,” said Sam Stovall, chief investment strategist at CFRA Research. “The average beat was 3.8 percentage points. So while no one thinks the EPS recession is cancelled, they likely believe it has been postponed.”

Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.

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