What Is an Earnings Recession and How Is It Measured?
Decode earnings recessions: understand their definition, how they're measured, and their key differences from economic recessions.
An earnings recession signifies a period where corporate profits decline, often for multiple consecutive quarters. This financial phenomenon is distinct from a broader economic downturn, though the two can be related. Understanding an earnings recession provides insight into the health of the corporate sector and its implications for investment markets. It focuses on business profitability, which influences stock valuations and investor sentiment.
Defining an Earnings Recession
An earnings recession is generally defined as two consecutive quarters of year-over-year decline in the aggregate corporate earnings of a broad market index. “Earnings” refers to the net income, or profit, that companies generate after accounting for all expenses. While often reported per-share for individual companies, an earnings recession focuses on the collective performance of many companies.
This aggregate measure typically refers to the earnings of companies within a major stock market index, such as the S&P 500. The S&P 500, representing 500 of the largest publicly traded U.S. companies, is a widely accepted proxy for the overall health of the U.S. corporate sector. A decline is measured year-over-year to neutralize seasonal fluctuations.
For example, if S&P 500 aggregate earnings in the first quarter are lower than the previous year’s first quarter, and the same pattern holds for the second quarter, an earnings recession is in effect. This two-quarter threshold provides a consistent benchmark for identifying corporate profit contraction, emphasizing sustained weakness rather than a single, isolated quarter.
Measuring Corporate Earnings Declines
Identifying an earnings recession involves systematically tracking and analyzing corporate financial data over time. The primary data sources are financial reports that publicly traded companies regularly file, such as quarterly and annual reports submitted to regulatory bodies like the Securities and Exchange Commission (SEC). These reports adhere to Generally Accepted Accounting Principles (GAAP), providing a standardized framework for reporting revenues, expenses, and net income.
Financial analysts and data providers aggregate reported earnings from hundreds of companies to calculate total or average earnings for major market indices. They also consider consensus estimates, which are average forecasts of future earnings. These estimates provide a forward-looking perspective, while reported earnings offer a historical view of actual performance. The most common metric for assessing an earnings recession is the year-over-year growth rate of aggregate earnings.
This year-over-year comparison helps normalize for typical business cycles and seasonal patterns that affect profitability. For instance, comparing a retail company’s fourth-quarter earnings to the previous year’s fourth quarter provides a more accurate picture of growth or decline. Analysts often track both “adjusted” earnings, which may exclude certain one-time gains or losses, and “unadjusted” (GAAP) earnings for a comprehensive understanding of corporate profitability trends.
Distinguishing from Economic Recessions
An earnings recession and an economic recession are distinct concepts, though they can often influence each other. An earnings recession specifically refers to a sustained decline in corporate profits, as measured by aggregate company earnings. This financial metric primarily reflects the profitability of businesses and their ability to generate income for shareholders.
In contrast, an economic recession is a broader downturn in overall economic activity, typically defined by a significant decline in real Gross Domestic Product (GDP) across various sectors. GDP measures the total value of goods and services produced within a country’s borders, encompassing consumer spending, business investment, government spending, and net exports. The National Bureau of Economic Research (NBER) is the official arbiter of U.S. economic recessions, considering a range of indicators beyond just GDP, including employment, industrial production, and retail sales.
While declining corporate profits can contribute to or coincide with a broader economic slowdown, an earnings recession does not automatically mean an economic recession is occurring. For example, companies might face temporary profit pressures due to rising input costs or supply chain issues without the entire economy contracting significantly. Conversely, an economic recession will almost certainly lead to an earnings recession, as reduced consumer spending and business activity directly impact corporate revenues and profitability.