One of the better market calls I’ve seen over the last 10 years was Richard Bernstein and David Rosenberg teaming up near the peak of the housing bubble to call for a profit recession and a full blown recession. At the time, both were Merrill analysts and I was a daily reader of their research. Bernstein was the equity guy and Rosenberg was the chief economist and they made one of the better Wall Street research duos around. They didn’t always agree, but in this case they did. And boy were they right.
In his latest note Richard Bernstein is growing increasingly concerned about corporate profits. He says:
“The US corporate profits story, however, is showing the first chink in the armor. The proportion of US companies reporting negative earnings surprises has jumped significantly so far in the current reporting period. With over half of the S&P 500 companies reported, 30% of the companies have reported negative earnings surprises. If reports continued in the same pattern for the remainder of the reporting season, the current reporting period would be the worst since 2008.
It seems increasingly clear that the profits cycle is slowing enough so that one should again consider the probability, albeit still reasonably low, of a profits recession. We are not suggesting that a profits recession is imminent. Rather, we are simply saying that the profits data appears for the first time in this cycle to be weakening enough to warrant consideration of such an outcome.”
I’d echo Bernstein’s note, but with a bit more specificity. We’ve seen a substantial increase in corporate profits in recent years thanks in large part to the gigantic federal budget deficit. We know from Kalecki’s work that budget deficits are a primary driver of profits. And in this cycle that has been particularly pronounced given the balance sheet recession and the weakness in the household sector. As I’ve noted previously, the odds of recession this year with a near $1 trillion deficit are very low. I’d say the same is true regarding a profit recession, but as we near 2013 the likelihood of much smaller deficits looms large. If we go the way of Europe 2013 could turn out to be a double whammy. Real recession AND profit recession. Stay tuned.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.