The financial world has been sounding the alarm recently over a potential recession in the U.S. and the global economy. The Federal Reserve is still fighting inflation, big tech companies are continuing layoffs, and companies are gearing up to report their 4th quarter earnings. With that, fear of an earnings recession is mounting.
Morgan Stanley’s investment chief warned clients that incoming earnings reports would underwhelm investors, potentially pushing major stock indexes to two-year lows even if the economy avoids a recession. As we head into earnings season, investors are keeping watch to see if these predictions come true.
Before answering that question, we should define a recession more generally. A recession is a significant, widespread, and prolonged downturn in economic activity. A common rule of thumb is that two consecutive quarters of negative gross domestic product (GDP) growth signal a recession.
However, note that the National Bureau of Economic Research uses much more data than GDP growth when deciding whether or not to call a recession. Every quarter, publicly traded companies must report their recent financial performance. This is an opportunity for investors to evaluate how the company has done and how the company is likely to do in the future.
An earnings recession, in simple terms, is when a majority of company profits fall year-over-year for two or more quarters in a row. For example, if 251 companies on the S&P 500 report decreasing year-over-year profits two quarters in a row, we’re in an earnings recession. The last time there was widespread talk of an earnings recession was in mid-2019. Keep in mind this was pre-Covid, and in early 2020 the economy fell into an actual recession.
The culprits
Morgan Stanley’s Chief Investment Officer, Michael Wilson, told investors in a note, “We’re not biting on this recent rally,” referring to the stock market rally between October and December last year. Wilson predicted that 4th quarter profits would disappoint investors and that an earnings recession is imminent.
But Wilson sees a glimmer of hope that once the quarterly reports reveal lower profits, the bear market will draw to a close by the second quarter. Several other analysts believe an earnings recession is inevitable this year and will set the scene for the next downturn. There are several factors causing this earnings recession, but it largely comes down to these:
Ongoing layoffs inside the tech sector have made consumers more conscious of spending habits. Consumer spending fell 0.2% in December, and the savings rate rose to 3.4%
Rising rates continue to be in the spotlight as the Federal Reserve actively combats inflation. The increase in prices across the board is contributing to consumers spending less
We saw market sell-offs in 2022 as investors were nervous about a potential recession. Ongoing fears of reduced profits may renew a selling season for stocks
The important thing now is for investors and businesses to prepare for a potential earning recession.
Preparing for an earnings recession
Before panicking, an investor should consider their investing goals. Think about whether you are a short-term or long-term investor. Not all courses of action should be the same, as each investor will have different goals and cost bases for each stock.
Short-term investors may note the possibility of an earnings recession continuing throughout the year, further dropping stock prices. These investors may want to claim profits before the trend continues. A long-term investor, conversely, may feel more flexibility since they can ride the stock for several years and give the economy time to make a comeback.
Not all downturns last a long time, and not all companies are affected equally. Remember the debatably V-shaped recovery we saw after the 2020 recession, especially for companies like Zoom or Wayfair that benefited from stay-at-home policies. As an investor, it’s generally good to compare apples to apples.
A company may report lower year-over-year revenue, but if the year prior was an unusual, record-breaking year for them, it doesn’t necessarily mean their fundamentals are in decline now.
Preparation in diversification
Never keep all your eggs in one basket, and never have just one investment in a portfolio. Investing too much capital into too few companies can expose you to more risk. In 2022, portfolios heavy with tech companies took the biggest hit, while balanced portfolios suffered less damage.
If an earnings recession does occur this year, it is likely to affect some market sectors more than others. Recession-proof sectors include consumer staples, healthcare, utilities, and budget businesses, to name a few.
Tools such as Q.ai make it easier to achieve a balance. Q.ai offers a wide selection of Investment Kits that balance risk and reward potential. There are Kits for long-term investing, protecting against inflation, and swinging for the fences with riskier assets. Users can select different AI-controlled features that hedge portfolios from market volatility. AI-powered Investment Kits take the guesswork out of investing.
Valuation fears
The tech sector saw massive growth in mid-2020, which continued going up through 2021. But a decline followed throughout 2022. During that period, valuations for tech companies could be misleading as the whole sector increased no matter how an individual stock performed.
This made it difficult for an analyst to determine a technology company’s worth. Earnings recessions can bring the same results. Even if a company reports positive numbers for its earnings, the stock price may slide as investor confidence wavers.
The bottom line
The last two times the Morgan Stanley model predicted earnings so far below average forecasts were during the dot-com crash and the Great Recession. Respectively, the S&P 500 fell 34% and 49%. They are now warning investors that this year’s rally also looks vulnerable.
Intelligent investors should watch for profit expectations and forecasts for the year. Earnings season has already begun and will continue over the next month. Investors should remember that adding defensive investments can balance a top-heavy portfolio.
A farm worker labors in a field near the town of Arvin, California. California's Central Valley is ... [+]..Getty Images
The last few years of tech news headlines were dominated by the word “fintech.” From massive fundraises to customer growth to product launches to scandals – new disruptors were everywhere in consumer banking, credit, payments, investment, and crypto. You’d have good reason to think we’ve hit peak fintech.
But the industries where most fintech is focused today represent only a fraction of the $23 trillion global financial services market. Products like Cash App, Robinhood, and Chime all tackle markets that are intuitive to everyday consumers, but consumers only see the tip of the iceberg.
Fintech’s next wave will focus on improving the less well-known, less ‘sexy’ markets fundamental to the global economy – and one of the largest markets primed for disruption is agriculture finance. 2022 saw a quiet but steady rise in fintech products being built for the massive agriculture industry, and they’re only getting started.
So – why disrupt agriculture finance to begin with? For the two best reasons in tech: the size of the market and the limitations of existing service providers.
Looking at the US alone, while farms contributed $134.7 billion to 2020 GDP, the industries dependent on farming – food manufacturing, food services, textiles – contributed over $1 trillion to the economy, accounting for over 5% of annual GDP. For many emerging markets, agriculture’s share of the overall economy is significantly higher – as much as 25% in some countries.
In a world where demand for food is expected to increase 70% by 2050, requiring $80 billion of annual investments, sluggish legacy players create a large and growing opportunity for new entrants.
While ‘agriculture finance’ refers to a large and heterogeneous set of activities – equipment lending, supply chain finance, commodities trading, farm banking – emerging fintechs have been focused on a few subsectors:
Agriculture Lending: Oxbury Bank in the UK raised fundingtwice last year to originate £650 million in agriculture loans to UK farmers. Tarfin in Turkey and Agro.Club in Eastern Europe provide supply chain financing to underserved medium-sized farmers who generally have to turn to their ag input suppliers for loans at exorbitant rates.
Companies like Crowde in Indonesia and Campo Capital in Brazil set up a peer-to-peer farm lending network. Players like Traive, AgroLend, Terra LUNA3+1.9% Magna, and Agree all tackle farm lending across Latin America. ProducePay allows Mexican farmers to take out loans secured by their US purchasers.
Farm Payments: Agriculture tends to be a lagging industry in the use of new payment methods, with transaction products like checks still estimated at 90% of the industry. Bushel recently launched a payment facilitator, digital wallet, and embedded payments feature that connects purchasers to 40% of grain providers in the US.
Pricing Data & Commodities Trading: The deep markets for grain, livestock, and other commodities are paramount to well-functioning agriculture supply chains, and accurate pricing data is the lifeblood of the industry. These markets let purchasers hedge against rising food prices, and large agriculture operations insure themselves against supply chain price fluctuations. FarmLead is one company focused on digitally connecting cash grain trading networks and integrating trade data into other farmer & grain buyer digital tools.
Insurance: Agriculture is the most delicately poised industrial sector when it comes to climate change risks, due to incidences of drought, flooding, and natural disasters. Insurance is incredibly vital to avoid the collapse of precarious farm systems, but traditional insurers have a hard time underwriting farms. That’s where platforms like World Cover, which provides satellite-enabled climate insurance to small farmers in countries like Ghana, Uganda, and Kenya, or GramCover, focused on providing insurance access to farmers in India, come into play.
Marketplaces: While e-commerce platforms like Shopify have opened up global retail markets to independent merchants, most farm marketplaces still operate as centralized offline exchanges. In Kenya, startups like Twiga Foods, FarmShine, ShambaPride, and M-Farm have built platforms to connect farmers directly with buyers, and list easily accessible price information.
Banking: The largest prize for fintechs is to win over new customers in one vertical, such as lending or insurance, and cross-sell them banking products built specifically for their needs. DeHaat in India provides financial services to farmers across credit, materials sourcing, advisory, and sales. New Zealand’s Figured provides financial planning tools for farmers. FarmDrive creates a credit score for Kenyan farmers. Seso provides hiring, workforce management, and asset management tools to simplify farm payrolls in the US.
Over the next decade, we will see a parallel market of products across all fintech categories – banking, lending, savings, payments, investment, HR, payroll, and trading – develop focused specifically on agriculture.
While agriculture may not be the most obvious market for fintech to pursue, it’s definitely one of the largest and most consequential, and I expect to see many of these companies grow quickly and dominate the next wave of fintech.
Media headlines out did each other in broadcasting China’s 6.8% contraction in GDP in the first quarter this year. It was indeed breaking news in that it was the first ever contraction since China started reporting quarterly GDP data in 1992. However, beyond the headlines, there is surprisingly little that is newsworthy.
It is not telling us anything we didn’t know already. A deep contraction was widely expected because of the massive quarantine and lockdown implemented to contain the COVID-19 outbreak, which practically shut down the economy. For example, Wuhan, the epicenter of the outbreak, ended its lockdown only on April 18 after 76 days.
Not surprisingly markets largely shrugged off the news. The S&P 500 rose 1.6% on April 17, after Nasdaq flipped into positive territory for the year the day before. Wall Street was not alone, Asian and European stocks also finished the week higher.
The slew of Beijing’s counter-cyclical policies to help the economy recover from COVID-19 has also been well and fully anticipated. Export rebate rates were raised on over 1,000 products to help exporters facing slumping demands. New infrastructure projects, many are planned and budgeted but now moved forward, have started in 25 provinces which will help prop up demand for industrial production and employment.
The People’s Bank of China, the central bank, has been adding liquidity to the financial system by cutting interest rates and reserve requirement ratio, as well as directing more lending to small and medium size businesses through loan guarantees. According to its data, bank loans grew by 11.5% year-on-year in March, the fastest growth rate since August 2018. This is an impressive feat.
China’s central bank is succeeding in raising bank credit growth in the midst of a massive economic contraction, something that is extremely difficult to do. None of these will bring about a V-shaped rebound, but they will pave the way for a recovery that will gather strength through the course of the second half of the year even if the global economy is still in recession.
The real news in China’s GDP contraction, which had come and gone hardly being noticed, is a policy document released without fanfare on March 30 outlining a set of wide-ranging structural reforms to be implemented in the aftermath of COVID-19. Ostensibly these structural reforms are needed, above and beyond the cyclical measures described, to revitalize an economy ravaged by COVID-19.
Upon closer scrutiny, however, it becomes clear that these are some of the deepest structural reforms that had been proposed and debated for the last two decades, and were strenuously resisted and successfully blocked or deferred by local governments. It appears that Beijing is taking advantage of COVID-19 and the unprecedented GDP contraction to ram through tough reforms that would otherwise be harder to do. What are these reforms?
These are deep and sweeping structural reforms regarding land use, the labor market, interest and exchange rates and the financial markets. They are what really matters if the Chinese economy is to become more market driven and efficient. On land use, current restrictions on how rural land can be sold and used for commercial purposes will be lifted, and the system of rural land acquisition and sales will be made market driven.
Behind these innocuous sounding policy-speak is the intention of slaying of one of communism’s sacred cows, the public ownership of land. Sweeping indeed. The removal of the household registration system, the hukou, is the centerpiece for reforming the labor market. This will be implemented nation-wide with the exceptions of a few mega-cities like Beijing and Shanghai.
For the tens of millions of migrant workers, they will be able to become fully-fledged urban residents in towns and cities where they are gainfully employed. They will be able to live with their families and have full access to urban health care, education and social welfare services.
Apart from lifting a highly discriminatory barrier that divides the Chinese population into two unequal tiers, at one stroke this reform will also increase urban consumption demand massively, especially in housing, while further enhancing the growth and dynamism of China’s burgeoning service sector.
The integration of benchmark lending and deposit rates with market rates will be the central plank of price reform in banking and finance, which will align them to become more market driven. The RMB exchange rate will be made more flexible. Civil servant salaries will be made comparable with the private sector.
The institutional infrastructure for listing, trading and delisting in the stock markets will be streamlined with stronger regulatory oversight, and the development of the bond market will be fast-tracked to offer an expanded range of products in size and varieties. And, finally, the opening up of the financial sector to full foreign participation will be accelerated.
Successfully implementing anyone of these structural reforms would be an achievement. Getting all of them done would be a game changer. This is clearly what Beijing intends to do by seizing the opportunity created by COVID-19 and the unprecedented GDP contraction. For those who welcome engagement with China, be prepared for a more dynamic and innovative Chinese economy.
For those who fear the rise of China, get ready to face a more determined China that marches to its own tune. Finally, the GDP contraction may well be the catalyst that Beijing needs to dispense with the GDP growth target altogether.
In the past decades, it has led provincial governments to boost production regardless of real demand in order to meet such targets, burdening China’s economic structure with wasteful over-capacity as a result. Allowing GDP growth to fluctuate with the rhythm of the business cycle would be an even greater achievement. That would be truly newsworthy.
The U.S. economy shrank for a second quarter in a row this year, a second estimate from the Bureau of Economic Analysis confirmed Thursday—once again signaling the start of a technical recession even as economists predict signs of a slowdown will only grow in the coming quarters, likely prompting the government to officially declare the economy has entered a recession.
The U.S. economy shrank at an annual rate of 0.6% in the second quarter despite average expectations originally calling for a 0.3% increase—marking the second consecutive quarter of negative gross domestic product growth and thereby signaling the economy has entered a technical recession, the Bureau of Economic Analysis reported in a second estimate released Thursday.
The figure was worse than the 0.5% decline economists were expecting, but ticked up from the 0.9% decline estimated last month.The government blamed the worse-than-expected figure on declines in residential investments (or home buying), federal government spending and business inventories, but said an uptick in exports and spending helped economic activity improve from last quarter’s decline of 1.6%.
According to one working definition, a recession comprises two consecutive quarters of negative GDP growth, says Wells Fargo senior economist Tim Quinlan—but it’s not the official one: Instead, the definitive call is up to the National Bureau of Economic Research, which defines a recession as “a significant decline in economic activity” lasting “more than a few months.”
Quinlan points out four of the six factors the NBER relies on to declare a recession—production, income, employment and spending—continued to signal expansion through May, but he notes production appears to be “losing steam” and income gains are struggling to keep up with inflation, all while unemployment claims rise and consumers start spending less.
Like other economists, Quinlan isn’t convinced economic indicators last quarter were indicative of a current recession, but he warns the economy is slowing and “it is starting to feel like [entering one] is only a matter of time.”
“We do not think the economy is in recession at present, but if our forecast is correct, this is not so much of a head fake as it is a harbinger of worse to come,” says Quinlan, who argues the negative GDP growth in the first half of the year isn’t likely a function of weak underlying demand but instead due to “one-off” volatile factors such as net exports and inventories. “We expect the loud wailing of an actual recession to begin early next year,” he adds.
The government will update its estimate, based on more complete data, for a third and final time in September.
Though economist projections continued to call for a return to growth in the second quarter, the Federal Reserve Bank of Atlanta’s GDPNow model in July began signaling the start of a technical recession, pushing its GDP forecast into negative territory after economic data showed consumer spending dropped in May. “The model’s long-run track record is excellent,” say DataTrek analysts Nicholas Colas and Jessica Rabe, pointing out its average error has been just 0.3 points since the Atlanta Fed started running it in 2011.
Ahead of the GDP print, the model projected the economy shrank 1.2% last quarter. It now projects the economy will grow 1.4% in the third quarter. The Fed’s withdrawal of pandemic stimulus measures and interest rate hikes this year have fueled concerns of impending recession. In July, Bank of America economists warned clients that prolonged inflation and the resulting interest rate hikes have unleashed a “worrying deterioration” in the economy, and particularly in the once-booming housing market.
“The Fed has become more committed to using its tools to help restore price stability, with a willingness to accept at least some pain in the process,” they said, predicting the economy will fall into recession over the next year.
In a morning note to clients, Goldman acknowledged a barrage of recently weak economic data—on consumer spending, manufacturing and international trade—has pushed some forecasts for second-quarter gross domestic product growth into negative territory, but called the projections “too pessimistic”.
After the U.S. economy unexpectedly shrank in the first quarter, a decline in the second quarter would constitute a technical recession, or two consecutive quarters of negative GDP growth, but the economists note they still believe the odds of a recession over the next year are only about 30%, and 50% over the next two years.
The team says it’s “doubtful” the National Bureau of Economic Research—whose declarations of recession are accepted by the government but don’t strictly follow the two-quarter rule—will say the economy is already in a recession given how strong the labor market remains, citing Friday data showing the U.S. gained a better-than-expected 372,000 jobs last month.
It would be “historically unusual” for the labor market to appear so strong during a recession, the Goldman team led by Jan Hatzius writes, noting that jobs have grown at an annualized pace of 3.7% over the last six months—roughly double the typical pace at the start of past recessions.
Despite remaining bullish, the team concedes labor market data typically lags other economic indicators and cautions that revisions to recent data could ultimately reveal that job growth may have been less robust, as was the case at the onset of the Great Recession.
In a separate note on Monday, Hatzius said the strong jobs report helped quell fears of an imminent recession, but also contained red flags: He notes the Census Bureau’s survey of 60,000 households has shown “essentially no job gains” for the past three months—casting doubt on the overall jobs figure, which is based on a survey of companies.
The U.S. economy posted its worst showing since the Covid-induced recession in the first quarter, shrinking 1.6% despite expectations originally calling for 1% growth. The worse-than-expected decline makes a second straight quarterly decline in GDP “much more likely,” Pantheon Macro chief economist Ian Shepherdson said earlier this month, forecasting that GDP fell 0.5% in the second quarter. However, like Goldman, he believes the NBER “very probably will not” declare a recession unless the job market meaningfully slows down.
Rather than purely going off technical recessions, the NBER defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” After losing more than 20 million jobs at the height of pandemic uncertainty in the spring of 2020, the labor market has quickly and forcefully led the economic recovery. However, prolonged inflation and rising interest rates, which tend to hurt company earnings, have sparked concerns about the broader economy and started taking their toll on the job market.
Recently booming technology and real estate companies have announced waves of layoffs this summer, and corporate giants including Amazon and Walmart have both signaled a slowdown in their hiring needs, with Walmart executives pointing to “overstaffing” as a drag on disappointing profits last quarter. “There is no doubt that a labor market slowdown is underway,” Hatzius said Monday, pointing to the layoffs and hiring freezes, in addition to a drop in job openings, rising jobless claims and data showing employment in the manufacturing and service industries has contracted.
The Bureau of Economic Analysis unveils its first estimate of second-quarter GDP growth—or decline—on July 28. It will then update the figure in August before releasing a final estimate in September.
I’m a senior reporter at Forbes focusing on markets and finance. I graduated from the University of North Carolina at Chapel Hill
Critics:
Even amid the Great Resignation, job demand skyrocketing, and shifting power dynamics between employers and employees that have led companies to enhance compensation packages and other perks, fears over job security still exist among a majority of workers. “Workers have experienced a tremendous amount of upheaval,” ADP Chief Economist Nela Richardson said during a recent CNBC Evolve Livestream. “The changes are both seismic and persistent.”
Richardson cited a recent ADP survey that found that only 20% of workers felt that their job was secure. That is just one byproduct of a new working landscape that is poised for further adjustment due to the looming threat of a recession and slower growth for companies, both tied to the fight against inflation.
Even as the economy has added over two million jobs this year, near 40-year high inflation is limiting the amount of money workers bring home and jeopardizing a full recovery for the economy from the Covid-19 crisis. “The real thing to focus on today is inflation,” Richardson said. “What inflation does is it erodes the value of that paycheck. … People are getting more take-home pay; it’s just not going as far as it used to.”
“Even though their wages have gone up and they’re growing faster, when all is said and done the average worker in the fourth quartile [of income earners] is only making about 2 bucks, a little less than 2 bucks [more] than they did in 2019 per hour,” Richardson said. “Despite all the talk of wage growth, it hasn’t been stellar when you think about inflation. Real wages are declining, and that’s true at every income level.”
U.S companies were expecting to pay an average 3.4% raise to workers in 2022, according to a January survey, outpacing the raises in both 2020 and 2021. While inflation was one reason given as to why, 74% of companies cited the tight labor market. Microsoft recently said it would be raising compensation. “This increased investment in our worldwide compensation reflects the ongoing commitment we have to providing a highly competitive experience for our employees,” a company spokesperson told CNBC.
To keep workers happy in an inflationary environment, organizations must also focus on boosting worker flexibility and security, Richardson said. ADP’s survey shows workers want flexibility over their time and more autonomy in their work. In spite of inflation, “our data shows that workers are willing to take pay cuts to get that kind of flexibility,” Richardson said.
This places even more importance on how companies are approaching bringing back workers to offices. Two-thirds of the U.S. workforce would consider changing jobs if they were required to return to the office full-time, according to ADP’s People at Work survey. This flexibility is also nuanced. “Having some flexibility about when you work is so much more important to the U.S. worker than flexibility about where you work,” Richardson said.
It could also aid a rebound for female workers. More than 1.4 million net jobs were lost among women since the pandemic began. Before the pandemic, women made up 46% of workers, but took on 53% of the losses, according to Richardson. To rebound from these losses, “flexibility could be the answer,” said Richardson. “It could be a way to accommodate the very real fact that women have a larger share of the family responsibilities.”
Richardson highlighted that the current labor shortage also encompasses skill sets. “We need to start training the workforce of tomorrow for the jobs that are needed, not today, but the jobs that will be needed tomorrow,” she said. Boosting skill sets will lead to increases in job security among workers. Despite the possibility of a recession, organizations must make changes and evolve now to deal with the problems they are facing today.
“Whenever the Fed is hiking, recession is always that shadow in the closet that may come out. There is always a probability of recession; that doesn’t necessarily mean that it should be a front-burner concern for companies who, recession or not, have to make hiring decisions,” she said.
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