The Compound and Friends - Ben Carlson on the Dreaded Earnings Recession

Episode Date: February 19, 2019

Ben Carlson and Josh Brown discuss the earnings recession. Hosted on Acast. See acast.com/privacy for more information. Learn more about your ad choices. Visit megaphone.fm/adchoices

All right. I'm on with Ben Carlson of A Wealth of Common Sense. Ben, say hello. Hello. So I thought your post about the dreaded earnings recession is one of the best things I've read so far this year because I think this is going to be the topic in the financial media between now and when we first start getting first quarter reports, which I guess begins in April. What was your idea behind writing it? This was actually one of those blog posts where you go in with an idea and maybe a conclusion already formed in your head, and then you run the data. And sometimes the data surprises you. And that actually happened to me in this case because I was kind of shocked. I wanted to see what happens when earnings are down in a specific year. How does that impact the stock market?

Well, wait, first of all, let's just define what is an earnings recession? Well, I just looked at it as earnings are down year over year. So I guess you could look at it any way you want, but I looked at it on a year over year basis. And so the Shiller data goes back to like 1870. I went to 1930 and looked at it on a year overover-year basis. The Shiller data goes back to 1870. I went to 1930 and looked at it on a year-over-year basis, whether earnings was growing or falling, basically. Okay. And you found how many years in that number of years did we have down earnings? So we were close to 90 years in total, and there was 30 of them that were down. Okay. So that's a third of the time earnings fall

year over year, which I think is probably the first thing you might've been surprised about. Yes. And then the other one was there were only a small percentage of those down years earnings where stocks were down too. And so it was like seven times out of those 30 that stocks were down. So more than two thirds of the time when earnings were down, stocks were actually up. And there was also on the flip side where earnings were up and stocks were down, which happened like 15 times. Yeah. So I'm looking at this. This table is incredible. So you're showing the seven years where both earnings and stocks went down. And then the column next to it is almost triple the size. And some recent years where earnings went down

year over year, but stocks went up anyway. 1982 is a really great example because that was the start of the longest bull market ever or one of the best bull markets ever. But even recently, in 2012, earnings were down year over year. And in 2015, earnings were down year over year and stocks went up. And here's the other flip side of this. There was actually eight years where earnings were down double digits, but stocks were up double digits. Which is incredible. Yeah. And obviously, some people would say, well, the stock market is forward looking and earnings are backward looking. But I still think this would surprise some people. And I tried to look at what happens, are stocks ever down the year before earnings are down? So there's those 30 years where

earnings were down. Only 12 of those years prior were stocks down. So the stock market doesn't do a very good job of predicting if we're looking at the prior 12 months of earnings being down in the ensuing calendar year. So the way that I kind of look at this is earnings are a roll-up, and you're probably a little more attuned to individual names than I am in terms of companies. But wouldn't you say that maybe earnings are more important for individual companies than the overall market in a lot of ways, especially in the short term? Yeah, you know why? So that's true. I think where earnings are important for the overall market is that they are the fundamental that the chief strategists build their S&P price targets on. So they say, we think the S&P is going to earn $130 per share of the index for 2019, and we think it should trade at 20 times that or 15 times that. So in that regard,

they're important for the market. But you're right, they have a bigger impact individually. And it's funny, thinking of those strateg strategies. I put a chart in here, too, that shows the earnings projections at the start of the year versus the end of the year. And almost in all cases, it starts out high and then it just slowly goes down throughout the year. So they almost always start out way too optimistic about what's going to happen with earnings. And then they slowly ratchet it down throughout the year. It's almost like you can set your clock to it. You know, the one exception to that is 18, which I find really interesting. I guess we got tax reform early in the year and then it took the street a while to figure out that, oh, wow, earnings are going to be a lot higher than we expected. But then that

didn't even end up helping. You had 24% earnings growth last year and negative 5% on the S&P, which means we got the entire benefit of that big boom in earnings in 17. And some people would say, well, stocks were down in 2018 because maybe that's forecasting lower earnings in 2019. I think maybe that's giving a little too much credit to the stock market because again, it's not very great at predicting this in the past. But yeah, I think these numbers are pretty counterintuitive because these are the sound bites you hear from people is that earnings are going to be great. So that means the stock market has something to hold it up or earnings are going to fall. So that means watch out below. It doesn't really necessarily follow that relationship. All right. We're going to wrap it right there.

Ben, thanks so much. Talk to you later. Thank you.