Two Consecutive Negative Quarterly Growth Rates in Business Earnings say we’re in a Recession

Posted by PITHOCRATES - March 9th, 2013

Week in Review

Business earnings drive everything in the economy.  Every dollar a person spends in the economy came from a business.  From someone spending their paycheck.  To someone spending their government assistance.  Because business provides every tax dollar the government collects.  Whether from the business directly.  Or from their employees.  So business earnings are everything.  If they’re not earning profits they’re not creating jobs.  And the fewer people that are working the less tax revenue there is.

Lakshman Achuthan with the Economic Cycle Research Institute (ECRI) looks at business earnings and has found a direct correlation between the growth rate of business earnings and recessionary periods.  Finding that whenever there were 2 or more consecutive quarters of a falling growth rate in business earnings we were in a recession.  Business Insider has reproduced his chart showing this correlation as well as quoting from his report (see CHART OF THE DAY: A Stock Market Trend Has Developed That Coincided With The Last 3 Recessions by Sam Ro posted 3/6/2013 on Business Insider).

This is a bar chart of S&P 500 operating earnings growth going back a quarter of a century on a consistent basis, as we understand from S&P. Others can choose their own definitions of operating earnings, but this is the data from S&P. In this chart, the height of the red bar indicates the number of consecutive quarters of negative earnings growth.

It is interesting that, historically, there have never been two or more quarters of negative earnings growth outside of a recessionary context. On this chart, showing the complete history of the data, the only times we see two or more quarters of negative growth are in 1990-91, 2000-01, 2007-09 and, incidentally, in 2012. This data is not susceptible to the kind of revisions one sees with government data. The point is that this type of earnings recession is not surprising when nominal GDP growth falls below 3.7%. So, even though the level of corporate profits is high, this evidence is also consistent with recession.

Follow the above link to see this chart.

The stock market is doing well now thanks to the Federal Reserve flooding the market with cheap dollars.  Investors are borrowing money to invest because of artificially low interest rates.  So the rich are getting richer in the Obama recovery.  But only the rich.  For an administration that is so concerned about ‘leveling the playing field’ their economic policies continually tip it in favor of the rich.  Who can make money even if the economy is not creating new jobs.  Which it isn’t.

All of these recessions can be traced back to John Maynard Keynes.  And Keynesian economics.  Playing with interest rates to stimulate economic activity.  The 1990-91 recession was made so bad because of the savings and loan (S&L) crisis.  Which itself is the result of government interventions into the private economy.  First they set a maximum limit on interest rates S&Ls (and banks) could offer.  Then the Keynesians (in particular President Nixon) decoupled the dollar from gold.  Unleashing inflation.  Causing S&Ls to lose business as people were withdrawing their money to save it in a higher-interest money market account.  Then they deregulated the S&Ls to try and save them from being devastated by rising inflation rates.  Which the S&Ls used to good advantage by borrowing money and loaning it at a higher rate.  Then Paul Volcker and President Reagan brought that destructive high inflation rate down. Leaving these S&Ls with a lot of high-cost debt on their books that they couldn’t service.  And while this was happening the real estate bubble burst.  Reducing what limited business they had.  Making that high-cost debt even more difficult to service.  Ultimately ending in the S&L crisis.  And the 1990-91 recession.

Fast forward to the subprime mortgage crisis and it was pretty much the same thing.  Bad government policy (artificially low interest rates and federal pressure to qualify the unqualified) created another massive real estate bubble.  This one built on toxic subprime mortgages.  Which banks sold to get them off of their books as fast as possible because they knew the mortgage holders couldn’t pay their mortgage payment if interest rates rose.  Increasing the rate, and the monthly payment, on their adjustable rate mortgage (ARM).  Fannie Mae and Freddie Mac bought and/or guaranteed these toxic mortgages and sold them to their friends on Wall Street.  Who chopped and diced them into collateralized debt obligations (CDOs).  Sold them as high-yield low-risk investments to unsuspecting investors.  And when interest rates rose and those ARMs reset at higher interest rates, and higher monthly payments, the subprime borrowers couldn’t pay their mortgages anymore.  Causing a slew of foreclosures.  Giving us the subprime mortgage crisis.  And the Great Recession.

In between these two government-caused disasters was another.  The dot-com bubble.  Where artificially low interest rates and irrational exuberance gave us the great dot-com bubble.  As venture capitalists poured money into the dot-coms who had nothing to sell, had no revenue and no profits.  But they could just as well be the next Microsoft.  And investors wanted to be in on the next Microsoft from the ground floor.  So they poured start-up capital into these start-ups.  Helped by those low interest rates.  And these start-ups created a high-tech boom.  Colleges couldn’t graduate people with computer science degrees fast enough to build the stuff that was going to make bazillions off of that new fangled thing.  The Internet.  Even cities got into the action.  Offering incentives for these dot-coms to open up shop in their cities.  Building expansive and expensive high-tech corridors for them.  Everyone was making money working for these companies.  Staffed with an army of new computer programmers.  Who were living well.  The brightest in their field earning some serious money.  So they and their bosses were getting rich.  Only one problem.  The companies weren’t.  For they had nothing to sell.  And when the start-up capital finally ran out the dot-com boom turned into the dot-com bust.  As the dot-com bubble burst.  And when it did the NASDAQ crashed in 2000.  When it became clear that all of President Clinton’s prosperity in the Nineties was nothing more than an illusion.  There would be 4 consecutive quarters of negative growth in business earnings before the dust finally settled.  One quarter worse than both the S&L crisis and the subprime mortgage crisis recessions.

And now here we are.  With 2 consecutive quarters of negative earnings growth under our belt.  Based on this chart this has happened only three times in the past 3 decades.  The 1990-91 recession.  The 2000-01 recession.  And the 2007-09 recession.  Which if his theory holds we are in store for another very nasty and very long recession.  No matter what the government economic data tells us.

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