The chart above shows S&P operating earnings (red line) and their 12-month forward forecasts shifted ahead 12 months to the month they are predicted to happen. The second chart shows the difference between the forecasts and actual releases. The shaded areas highlight official recessions.

Wall Street is one of the few places where practice does not make perfect. Notice that every subsequent recession sees larger earnings error rates than the previous recession.

During the 1990/1991 recession, top-down forecasters (strategists) were too optimistic by 10%. Bottom-up forecasters (adding up the 500 company forecasts) were too optimistic by 25%.

During the 2000/2001 recession, top-down forecasters were too optimistic by 25%. Bottom-up forecasters were too optimistic by 23%.

During the 2007/2009 “Great Recession”, top-down forecasters were too optimistic by 39.6%. Bottom-up forecasters were too optimistic by 40%.

Also notice the difference between the top-down and bottom-up forecasts. Current strategists are getting significantly worse at predicting earnings than their 1980s and 1990s counterparts.

What Does This Mean?

If the economy goes into recession, earnings forecasts are not 10% to 12% too high. Instead they might be 20% to 40% too high. In other words,if the economy goes into recession, the earnings forecasts are horribly wrong. They might be so wrong that one can make the case that the market might be overvalued. We believe this is part of what is bothering the markets, the epiphany that the economy is much weaker than expected and a recession will blow a hole in earnings forecasts to the point that the market might not be cheap anymore.


Source: Bianco Research

Category: Earnings

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

15 Responses to “Another Huge Earnings Miss Coming?”

  1. djorge24 says:

    Probably a function of increased levg in corp balance sheets? More fixed costs causes you miss forecasts by a wider margin when sales turn down. Of course, you would think equity analysts would account for that…

  2. [...] What happens to earnings in a recession?  (Big Picture) [...]

  3. Boots or Hearts says:

    Nice chart/post. Reminds me of Grantham pegging a FV of at best of 950 on the S&P, and that profits and prices are mean reverting.

    I read this am that Achuthan stepped up his recession call.


    BR: Here’s Lakshman Achuthan

  4. wj says:

    Here are a couple more interesting charts:


    Note on this chart how the percent of job losses gets greater and lasts longer in each recession: 1981,1990,2001,2007:


  5. san_fran_sam says:

    I’ve seen this error rate issue discussed before. Perhaps even here at TBP.

    I am just wondering though if the increasing error rate is a function of the severity of the recessions. 2008-2009 was worse than 2001 which was worse than 1990-91.

    It would be interesting to see this chart for the earlier post-WWII recessions when the recession were more normal. That is, business cycle/inventory driven.

    Just asking.

  6. Hurricaner says:

    Question….what if there is no recession…just a muddle along? Are the earnings estimates still too high?

  7. DrungoHazewood says:

    Hussman has been on recession watch for some time. His macro calls are pretty good, his returns have been avg. He was brutally whipsawed in 2008-09, which really hurt his long term returns.

  8. Blurtman says:

    ” In other words,if the economy goes into recession, the earnings forecasts are horribly wrong. They might be so wrong that one can make the case that the market might be overvalued.”

    Jeepers, who could have known? You are kidding me to even attempt to straight face this, right?

  9. RW says:

    Analysts often miss turning points but, upside bias aside — you tend to get screamed at or, worse yet, under-employed making sell calls — it wouldn’t surprise me if that is because they read each others’ work too often: Humans are social animals after all and we do herd.

    WRT Hussman, like everyone else with a fresh-water econ background, his macro calls have been poor and that is the main reason he has underperformed the past few years — he’s a pro and adjusted his tactics but while that made whipsaws much smaller it also made them more frequent — but there are few better than he when it comes to analyzing market value and internal action; I read him regularly and have adjusted my long-term investment ideas in response more than once.

  10. Concerned Neighbour says:

    What happens if corporations are actually made to pay the corporate tax rate? Which is to say, what if the corporate tax loopholes, of which there are so many, were actually eliminated? Even if you lowered marginal tax rates at the same time, it would still mean that companies like GE would pay more then they are now, eating into profits, making the S&P profit forecast even more unreasonable.

    If you believe revenue has to be part of the solution, and that corporate tax loopholes are low hanging fruit in this regard, you should be stripping at least 5-10% from profit forecasts IMO.

  11. rd says:

    The increasing error rate may be partially due to the increasng importance of the “service” economy.

    If the companies are focused on growing the food, making the goods, and transporting them to our door that we need on a daily basis, then the magnitude of the swings will be limited as there are limited options for eliminating these items.

    However, if more and more of the profits are derived from “services” that are not physical necessities, then they become much more optional. In particular, if sectors (financials) report much of their profits due to speculation and trading with each other, instead of providing vital economic service, then their profits could vanish overnight if the desire to use their services goes away as there is no real fundamental economic need.

    A CDS may be a profitable thing in good times for a financial service company, but in the end it has very little to do with putting a plate of food on my table or a car in the driveway. It could vanish entirely and the vast majority of citizens would never even have known it existed and its disappearance would be unlikely to impact anything in their lives (other than the effects of another financial crisis).

  12. BenitoElRojo says:

    I wonder if the increasing size of the missed forecasts is simply due to the linear extrapolation that the forecasters are using. The greater the rate that earnings are increasing, the greater the positive slope on the graph. The greater the slope, the higher the 12-month forecasted earnings. When earnings turn south, the higher the slope of the previous growth cycle, the greater the “miss”.
    Another aspect of the graph to note is that a high growth rate (steep positive slope) correlates to a higher rate of earnings shrinkage (steeper negative slope) during a recession.
    What is scary is that the latest growth cycle has the steepest slope of all growth cycles on the graph. If a recession is imminent as the ECRI claimed today, and earnings follow the pattern of a steep drop following following a steep gain, then we could see earnings misses greater than we saw in 2008. If you combine that with the P/E ratios typically seen at bear market bottoms, then this market could have a long way to fall.
    Of course I understand, as Barry so often reminds us, that our primitive brains are susceptible to finding patterns where there are none. Food for thought, nonetheless.

  13. Mike C says:


    I’m wondering if you think this script is the most likely:


    We had a 100% rally instead of 70% but the basic pattern is holding so far. A 25-30% drop would put us around 950-1050 on the S&P 500. Assuming a mild recession and a not too large drop in SPX earnings, that may actually be a pretty reasonable valuation for long-term investors to really start accumulating. Maybe a cyclical bottom in March 2012?

  14. pintelho says:

    to me it means MBAs are learning the wrong skills..either in school or “on-the-job”

  15. jbutterfill says:

    earnings are inflationary and therefore over the longer term trend upwards, therefore any fall is likely to look larger the previous recessions when looking at absolute values – surely when doing this exercise the earnings should be seen on a logarithmic scale – if done this ways the troughs dont look like they are growing at every recession – with the exception of the credit crisis.

    An interesting this is how earnings are continually growing over the very long term, almost following an exponential curve – is this due to ever improving production efficiencies? will it continue? maybe if we build good robots..