US corporate earnings trends, historically a leading indicator of recessions, will continue to weaken through 2023, Fitch Ratings says. We expect below-trend GDP growth in 2022, given weak incoming data and a hawkish Fed interest rate stance, with a recession increasingly likely in 2023. The effect on issuer credit ratings will largely depend on the degree of cash flow pressure and headroom within Fitch’s current sensitivities.
In a recently published report, U.S. Corporate Earnings Likely to Increasingly Signal Recession and Stagflation Risks, Fitch’s homebuilding; airlines; autos; retail; and gaming, lodging & leisure sector analysts discuss how they are considering the potential effects of a recession and stagflation in financial projections. An economic downturn that adversely affects demand and pricing power could reduce rating headroom, with challenges amplified if inflation stays high. An aggressive financial strategy, such as debt-financed share repurchases, while cash flow is pressured could be the impetus for negative rating actions.
Corporate profits declined an average of four quarters prior to past downturns, based on our analysis of the US Bureau of Economic Analysis data. The peak-to-trough decline in after-tax profits during the last 12 recessions averaged 19%, with revenue and margin declines varying across sectors. After-tax profits as a percentage of GDP declined by an average of 3%.
S&P 1500 Index EBITDA growth softened a bit in 2Q22, with 40% of the index’s constituents revising current fiscal year guidance down as of Aug. 29, 2022, compared with 28% at the same time last year, per FactSet data. Downward revisions to consensus expectations for 2023 have been slow, but will likely accelerate as monetary tightening continues in order to reduce inflation and economic growth slows.
