TheStreet

U.S. corporate profits are forecast to shrink for the first time in nearly three years this quarter, according to Refinitiv data, raising the risk of a potential earnings recession that would parallel a slowdown in global economic growth and renewed rallies in safe-haven assets.

With around two thirds of S&P 500 companies reporting December quarter earnings for far this season, profits are expected to grow by a stronger-than-expected 16.8% from the same period last year, I/E/B/S Refinitiv data suggests. That's more than 1 percentage point higher than forecast at the start of the reporting season, thanks to an earnings "beat" rate of around 71.5%. However, with negative earnings projections outweighing positive ones, and the impact of $1.5 trillion in tax cuts rolling off from the comparative period, first quarter earnings are expected to shrink by 0.3%, the first dip since the second quarter of 2016. 

"The proportion of beats is in line with history and less stellar than in recent quarters, while forward-looking earnings guidance has also come down," Bank of America Merrill Lynch noted in a recent client report. "As a result, 2019 consensus EPS growth expectations have fallen from 7% at the start of January to in line with our forecast of 5% today, suggesting estimate cuts may slow from here."

"Trade remains a key risk, but has so far negatively impacted only around 10% of the index," BAML said.

The current first quarter estimate compares to a 26.5% growth rate over the same period last year, and although Refinitv data points to a modest rebound of 3.6% earnings growth over the three months ending in June, the weakness has raised the prospect of a so-called earnings recession -- where profits decline for two consecutive quarters -- for the first time since 2016.

That said, the S&P 500 has gained just over 8% so far this year, however, suggesting investors aren't as concerned by the negative earnings outlook a they have been in the past, perhaps given the fact that while global growth forecasts have been notably weaker in the run up to the current earnings season, the U.S. Federal Reserve has been keen to stress its "patience" on future rate hikes.

The International Monetary Fund cut its global economic growth forecast for the second time in three months in January, citing concerns over unresolved trade conflicts between Washington, Brussels and Beijing and slowing activity in Europe.

The Fund sees the world economy growing at 3.5% this year and 3.6% in 2020, clipping 0.2 and 0.1 percentage points respectively from is prior estimate, published as part of its regular World Economic Update in November.

That assessment, as well as recent cuts in growth forecasts by the Bank of England and the European Commission, has pushed benchmark German bund yield under 10 basis points, the lowest in more than two years, and taken the U.S. dollar index to a six week high against a basket of six of its global peers.

Curiously, while China's economy is expected to slow significantly this year, following its weakest advance in a decade of 2018, and trade talks between Washington and Beijing have shown little progress ahead of their March 2 deadline, BAML analysts noted that U.S. companies haven't been overly concerned with either impact during discussions with investors. 

"Of the 55 companies citing China trends on earnings calls, nearly half have been positive, while slightly less than half have been negative (the rest mixed)," BAML noted. "Just 43 companies overall have mentioned trade/tariffs, which could suggest uncertainty plus the fact that many already highlighted expected impacts (or lack thereof) in 3Q."

"About half of the mentions (around 10% of reported companies) cited a negative impact, vs the other half citing limited/no impact or managing any impact through pricing or supply chain shifts," BAML said.

That assessment suggest a resilience for U.S. company profits that hasn't been evident in other markets around the world.

Japan, for instance, is around half way through its third quarter earnings season, and profits are expected to fall by 2.6%, the steepest decline since the 2011 Fukushima earthquake and tsunami that killed nearly 16,000 people and cost the economy an estimated $235 billion.

European earnings, however, are likely to improve, but from a much lower base, to around a 2.7% growth rate in the first quarter of this year from around 2.3% over the final three months of last year.