An earnings recession is an important indicator of economic health. When corporate profits decline for at least two consecutive quarters, economists and traders refer to this trend as an earnings recession.

While it doesn’t always spell disaster for the broader economy, understanding its implications can help investors, businesses, and policymakers navigate potential challenges.

In this article, we’ll break down the concept of earnings recession in simple terms and explore its causes, impact on markets, and much more.

What is an Earnings Recession?

An earnings recession occurs when companies’ profits or earnings drop for a period of time. Normally, companies report their profits every three months (it’s known as “quarterly earnings”). If many companies report smaller profits consistently for two quarters or more, that’s what we call earnings recession.

This is often viewed as a warning sign for the economy, though it doesn’t necessarily lead to an economic recession.

Key Characteristics:

1. Decline in corporate earnings over six months or longer.
2. Common in industries sensitive to consumer demand, like retail or manufacturing.
3. May precede broader economic slowdowns or stock market corrections.

For example, during the pandemic, many businesses faced earnings recessions due to lower consumer spending and disrupted supply chains.

What Causes an Earnings Recession?

Several factors can trigger an earnings recession, including:

• Weak Consumer Demand: To be honest, if people don’t buy as much as before, businesses will struggle to make enough profit simply because more buying customers equals more profit.

  Ok, let’s say, for example, if the economy is down or inflation is high, people will reduce spending, and I’m a living prove of this, they won’t buy new phones, cars, or even basic things like food and clothes. This is one of the major causes, and I will attest to this personally.

• Rising Costs: Another cause of this is the increase in cost of raw materials or labour, it most times affects the profits of companies and businesses.
  Not to talk much, but take a look at what happened when fuel prices rose,  transportation and production costs also rose. So, if the companies no longer pass those costs to customers through price hikes, their profits go down.
• Interest Rates: When central banks like CBN (for Nigeria) or the Fed (for the U.S.) increase interest rates, borrowing money becomes more expensive. Companies no longer borrow cheap funds to expand or pay off old debts, because I don’t think there’s anyone or company, not even me, that will like to borrow with high interest rate, and this also slowdown in investment and growth leads to reduced earnings.
• Economic Downturns: When the economy itself is in recession, businesses tend to suffer because general consumer spending and business investments drop. People and companies are not as confident to spend or invest money, so businesses struggle to keep up their earnings.
• Competition & Market Saturation: If a market gets overcrowded with too many companies offering the same product or service, prices go down. The companies will need to cut prices or offer discounts to attract customers, which affects their profits. I guess you are familiar with black friday
• Global Supply Chain Disruptions: For businesses that depend on raw materials or goods from other countries, if global supply chains are disrupted (like when we see things like shipping delays or trade wars), it will affect their ability to deliver goods, leading to a loss in revenue.
• Poor Management or Strategic Mistakes: Sometimes, its not all about the market or economy. Poor decision-making by the company’s leadership, like bad investments or wrong business moves, can also cause earnings to fall.  They can also fail to adapt to changes in technology or customer preferences.

Earnings Recession vs. Economic Recession

While the terms sound similar, they’re not the same. An economic recession involves a broad decline in GDP, employment, and production. An earnings recession, on the other hand, specifically focuses on the decline in corporate profits.

However, the two can overlap. For instance, the earnings recession during 2008 also coincided with a full-blown global financial crisis.

How Does an Earnings Recession Impact Stock Markets?

An earnings recession often leads to increased stock market volatility. Investors may lose confidence in companies’ ability to grow, causing stock prices to drop. Historical trends show that the S&P 500 tends to perform poorly during prolonged periods of declining profits.

However, not all sectors are equally affected. Defensive industries, like healthcare and utilities, tend to perform better during earnings recessions.

Frequently Asked Questions

1. Is an Earnings Recession a Bad Sign for the Economy?

Not always. While it signals challenges for corporations, it doesn’t necessarily lead to an economic downturn.

2. How Can I Tell If We’re in an Earnings Recession?

Track quarterly earnings reports from major companies or indices like the S&P 500. Two consecutive declines typically confirm an earnings recession.

3. What’s the Difference Between an Earnings Recession and a Bear Market?

An earnings recession focuses on declining profits, while a bear market is defined by a 20% or greater drop in stock prices.

Conclusion

An earnings recession serves as an early warning for shifts in economic conditions and corporate health. By understanding its causes and effects, you can make smarter financial decisions, whether you’re investing in the stock market or managing a business.

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Recession