Seasonally-adjusted EPS could decline slightly in Q2. Does this herald a sustained downtrend in U.S. earnings?
T he second quarter earnings season is not off to an impressive start and guidance has been particularly poor, suggesting a slight decline in EPS in the second quarter (after adjusting for seasonality).
The stall in the uptrend is concerning because earnings have acted as a key pillar of support for the equity market since the economic recovery began three years ago. Even just a flattening-off in the level of EPS could erode the argument that equities remain the cheapest asset class from a relative value perspective. More importantly though, earnings rarely contract on a sustained basis outside of recessions. When a contraction did occur in a non-recessionary period, it was always associated with a mid-cycle slowdown in output alongside accelerating labor costs. Currently, the economy is in a soft patch, but unit labor costs (ULC) remain very tame and corporate GDP growth has accelerated recently relative to ULC growth. A temporary contraction in year-over-year earnings growth is possible, but should be shallow in nature barring a significant further downdraft in global economic momentum, or a spike in the dollar.
Bottom line: A sustained downtrend in earnings is unlikely absent a recession or a surge in unit labor costs.