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Insight: Earnings and Business Cycle

Earnings Revisions Can’t Predict the Business Cycle

Although they grab attention on the Street, earnings revisions contain little information about the business cycle. We find the median revision trend at the outset of a recession is statistically indistinct from the long-run trend, with financial analysts showing no ability to anticipate recessions as a group.

As the chart below shows, revisions to earnings forecasts for recession years (and the years immediately prior to a recession) display little statistically significant difference from the long-run median revision pattern. In fact, forecasts for such years tend to be higher than the long-run median—although still within one standard deviation of it.

By contrast, once an economy enters recession, earnings revisions are consistently between the 10th percentile and the -2 standard deviation of the long-run average.

The chart also shows that analysts begin to revise down their earnings estimates for the year prior to a recession late in the year—but seem to be somewhat in denial about the recession to come in the year ahead, only slashing their numbers after the downturn begins.

On net, earnings estimates typically decline over the course of the year, and recessions are associated with more significant revisions (-25%) than seen recently. However, analysts and economists alike often have no idea that a turn in the business cycle is just 12 months ahead.

@ Roubini Econoteam



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