3 Things: 1998, NIM, Dumb Money

The 1998 Profits Recession

I recently quoted the importance of the current profits “recession” as it relates to potential market outcomes for investors.

“To me, the pre-conditions for this profits recession speak to downside risk, both for risk assets and for the real economy. None of the data speaks to recession in the real economy right now. We are seeing a slowing of job growth and likely of trend economic growth as well. But with a profits recession hitting, the potential for further downside is high.”

Since earnings, and ultimately profits, are derived from underlying economic activity it only makes sense that profits would be a leading indicator of deteriorating economic activity. However, could the recent decline in profits be a “false flag?”

Sam Ro recently discussed this idea stating:

Corporate profits have been lackluster lately, with growth flattening out and turning negative. Declining profits typically signal that an economic recession is in our midst. But not always.

More and more analysts are coming out arguing that this could be one of those corporate profits recessions that don’t coincide with economy-wide recessions.

As Jim O’Sullivan writes: ‘Profits recessions are usually associated with recessions for the economy as a whole, so the data are certainly attention-grabbing. There have been exceptions, however—most notably the 1998 period we have been highlighting as fairly analogous to the current time.

Back then, global growth and exports weakened significantly, oil and other commodity prices fell sharply and the dollar surged, yet overall U.S. growth remained solid. Strength in domestic demand offset weakness in foreign demand, as we illustrate in the chart.'”

There are just two problems with Jim O’Sullivan’s comments when it comes to investors.

First, the 1998 “profits recession” did not immediately result in an economic recession and coincident “bear market”, it was merely postponed as the market “melted up”in the midst of the “dot.com” bubble. In the short-term investors made gains, but the subsequent collapse wiped them out and more.