With the third-quarter earnings season nearing a close, the year-over-year profits for Standard & Poor's 500 companies declined 3%, according to Thomson Financial. The drop marks the first quarter in five years that American corporations have recorded an aggregate earnings decline. Thus far, 461 companies in the S&P 500 have reported earnings.
The last time investors experienced a negative quarter was in the first quarter of 2002, when the market logged an 11.5% decline. Profit declines during the recession of 2001 included a third-quarter drop of 21.6% and a 21.5% drop in the fourth quarter.
"Profit declines portend recession if they lead to cutbacks in capital spending and labor," says John Lonski, chief economist at Moody's Investors Service. Lonski believes there is about a 40% chance of recession at this time, as the housing recession continues to spill over into the rest of the economy.
First, not all S&P companies have reported earnings, so its possible this overall earnings number could turn positive over the next few weeks.
Earnings are the mother's milk of stock market investors. Most valuation models are based (at least partially) on a price to earnings ratio, or PE. As earnings increased these models assume stock prices will increase as well because a company becomes more valuable. However, as earnings drop these models assume that stock prices will drop as well.
