A Profit Recession Is Brewing That‘ll Be the ’Worst in 50 Years,' Expert Predicts

Traders work at the New York Stock Exchange (NYSE) at Wall Street in New York on Feb. 24, 2020. Johannes Eisele/AFP via Getty Images

As Americans grow concerned that the U.S. economy could tip into a full-blown recession, one expert says evidence suggests that U.S. corporations will soon be hammered by a profit recession of their own as many have been unable to pass soaring input costs along to inflation-weary consumers and will have to scale back their earnings forecasts, pressuring stocks.

In a recent interview on the Wealthion program, MacroMavens founder and economist Stephanie Pomboy explained that a measure that she relies on as a proxy for corporate profit margins has plunged to lows not seen since the mid-1970s.

Pomboy said that this profit proxy gauge basically plots the difference over time between two separate inflation measures—the Consumer Price Index (CPI) and the Producer Price Index (PPI)—or consumer price inflation and business input cost inflation, respectively.

“I’ve been tracking this CPI vs. PPI, which is my profit proxy,” Pomboy said. “It’s basically measuring input costs to businesses versus their ability to pass them on consumers.”

‘Worst Profit Recession in 50 Years’

If the gauge dips into negative territory, it means that consumer price inflation is higher than producer price inflation, reflecting a situation in which businesses are absorbing part of the inflationary surge and taking a hit to their bottom lines.

“In the last year, we’ve seen a gap between the two of those that implies the most acute margin squeeze since the 1970s,” she said.

She described the implications as a looming “profit recession” for U.S. businesses, arguing that Wall Street earnings forecasts will likely face sharp downward revisions, putting pressure on already-battered equity markets.

“It’s not only forecasting a profit recession, it’s forecasting the worst profit recession in 50 years,” she said.

‘Pie In The Sky’ Forecasts

Pomboy said that, despite the fact that the profit proxy gauge suggests a sharp drop in earnings, Wall Street analysts continue to project solid profit growth for U.S. businesses this year and the next.

Analysts are forecasting around 5 percent earnings growth for the rest of the year for companies listed on the S&P 500 excluding energy, she said, adding that forecasts are in the double-digits when it comes to firms in the consumer discretionary sector.

Consumer discretionary, or non-essential consumer spending, is poised to take the brunt of the recent sharp downturn in consumer sentiment—which is a leading indicator for spending—as inflation-weary Americans look to limit their buying to necessities, she said.

Describing consumer discretionary as the “point of maximum pain” amid today’s inflationary environment, she said forecasts for profit growth in this sector remain at a “staggering” 24 percent for 2022 and 38 percent in 2023.

“Calling these forecasts pie in the sky is to demean it enormously,” she said. “Down 24 [percent] would be more like it,” she added.

‘Substantially More Pain’

Her grim forecast comes as a number of major U.S. corporations have said they are stuck with extra inventory that they will have to mark down to get rid of, with impacts on bottom lines.

Target recently warned investors that its profits would take a short-term hit as it seeks to remove excess inventory.

Pomboy predicted that as earnings forecasts get downgraded, this will translate into “substantially more pain on the stock price.”

Stocks, and other risk assets, have taken a beating in recent months, with the benchmark S&P 500 now trading in a bear market.

It comes amid signs that the U.S. economy is slowing and could tip into recession as the Federal Reserve hikes rates to tame high inflation.

Albert Edwards, Société Générale’s chief market strategist, said in a recent research note that investors haven’t yet fully priced in the threat of a recession, meaning stocks are poised for more downside.

“Market meltdown looms,” he said in the note, as per Markets Insider. “The Fed has, in an act of penance for allowing inflation to get out of control, donned a horse-hair shirt and is fully prepared to drive the US economy into a recession.”

The Fed hiked rates by 75 basis points at its last policy meeting and is poised to keep tightening. Investor bets on future interest rate increases now put the odds of another 75 basis point hike when the Fed meets again in July at 93.3 percent.