Earnings Will Take Up to 4 Years to Recover, Leuthold Says

So when will corporate earnings get back to their peak, reached in 2019? How about three to four years from now.

That’s the bleak prognostication of Doug Ramsey, Leuthold Group’s CIO, based on the record of previous slides and a pessimistic take on our current economic travail. Earnings per share (EPS) for the S&P 500 last year were $139.47, a record, albeit just a small advance over 2018’s strong showing.

Over the past 65 years, the index encountered a 21% median earnings loss, and its EPS took a median 13 quarters, or a little more than three years, to return to its previous prominence.

“If the recession that began in March turns out to be a median cyclical downturn (a charitable assumption at this point), expect a new highwater mark in GAAP EPS during the first quarter of 2023,” Ramsey wrote in a research note, referring to generally accepted accounting principles, or GAAP.

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These earnings droughts are more common than many realize. From 1956 on, Ramsey wrote, the S&P 500’s EPS has “spent a full 29 years laboring below a previous business cycle peak.” Presumably, research firm Leuthold chose the period beginning in the mid-1950s to avoid the distortion of the post-World War II downturn, when the nation was struggling to return to a civilian economy.

The shortest recovery times occurred during three successive recessions in the 1970s and early 1980s, when inflation was high (seven, seven, and 10 quarters). That was because inflation artificially pumped up earnings. If you cull out the trio of inflation-skewed recession EPS numbers, Ramsey figured, then the median recovery times lengthens to 17 quarters, or a little more than four years.

How about the aftermath of the Great Recession, which ended 11 years ago? By Leuthold’s calculations, that EPS restoration took 17 quarters. And this span featured a dizzying plummet in S&P 500 EPS. From the outset of the recession in late 2007 to its low point in March 2009, EPS dropped 86%.

Right now, the consensus of analysts is that earnings will slide just 8.3% for all of 2020, a decrease that a number of critics find fancifully optimistic. After all, many businesses are shuttered and failing, plus unemployment claims have reached 1930s levels, due to the virus outbreak. JPMorgan forecasts a 40% shrinking of the economy in the second quarter this year.

To Ramsey, the galling aspect about the current market, which has recovered about half the ground it lost in the February-March sell-off, is that stocks still are pricey. The index’s price/earnings (P/E) ratio is 21.5, he noted, which is higher than 85% of all readings since 1957 and above the 18 P/E right before the last recession hit. For the record, the apex for the P/E multiple was 35, reached in 1999, during the dot-com bubble.