Profit Recession On Deck Due To Surging Dollar And Plunging Crude, Deutsche Warns

Tyler Durden's picture

Plunging oil prices may be unambiguously good for those US consumers who have to gas up ever two weeks for their work commute (assuming they are not part of the 101.5 million working age Americans who don't have a job), but they are unambiguously bad for those US corporations which have a direct top-line exposure to energy, or are located downstream in the energy vertical and are impacted by the profitability (and viability) of energy companies. A simple example: the bulk of new jobs created under the Obama administration has been almost entirely courtesy of the shale boom, as reported previously: a boom which may quickly transform into a bust if the tumbling price of crude isn't arrested. And with the Energy sector responsible for a third of S&P 500 capex (or the I in the Y=C+I+G+(X-M) equation), slashing energy spending budgets (as ConocoPhillips already warned), the result would be a material drop in GDP as well.

But while there will be much debate over the economic pros and cons to tumbling oil prices (there is no debate if the plunge is confirmed to be the result of a global collapse in demand: that would scream global recession) with a definitive answer unlikely to be forthcoming for at least several quarters, when it comes to corporate profitability the outcome is already known, because between plunging oil prices and the soaring dollar, what is most likely next in store for the US economy may or may not be a full-blown economic recession, but a profit recession seems virtually inevitable.

What is a profit recession? This is how Deutsche Bank's David Bianco explains it:

There have been three S&P profit recessions since 1960: 1967, 1985/86, 1998

We define a profit recession as 2 quarters of down S&P EPS y/y when real GDP is up. It’s not a common thing, but it occurred in 3 of the 4 US expansions that lasted 5+ years. The cause of divergence between economic growth and profits is one of capacity growth outpacing demand growth and a significant deterioration in pricing power, which is usually most pronounced at Materials, Energy and Industrials. Dollar strength and commodity price weakness are profit recession hallmarks. We still expect up S&P EPS, however our 2015E EPS of $123 is at risk from current oil prices and the pace of dollar strength.

Dollar surges and oil price swoons are the typical causes of profit recessions

The 1998 profit recession was short, only 2 quarters and its principle cause was a ~30% oil price decline, mostly affecting Energy and Materials. Financials earnings also declined slightly on market turbulence associated with the Russian default. The 1985/86 profit recession was 4 quarters. Caused by a very strong dollar that contributed to a ~40% oil price plunge, which both weighed heavily on US capex and exports. Earnings declined most at Materials and Energy, followed by Tech, Industrials, Consumer Discretionary and Health Care. It was a broad based profit recession despite 4%+ real GDP. The 1967 profit recession lasted 3 quarters on GDP deceleration from Fed Chairman William Martin’s famous “punch bowl removal” policy tightening, exacerbated by GBP devaluation. The 2001 recession is often described as mostly a profit recession on the sharp downturn in US capex on tech and telecom equipment.

Small bear markets at onset of profit recessions in 1966, 1998, but not 1985/86

From 2/66-10/66 the S&P fell 23%, its worst decline outside a recession except 1987. This was due to a stern Fed on rising unit labor costs. The Fed eased after the S&P fell and GDP slowed, but then resumed hikes in mid 1967. From 7/98-10/98 the S&P fell 19% on Russia’s default in August and oil’s extended slide to $9/bbl. The S&P kept a 20+ PE. 1985/86 did not suffer a correction, despite prolonged poor EPS. Dollar strength and oil weakness helped convince investors that double-digit inflation and interest rates were quashed and the S&P PE climbed from 10 at 1985’s start to 15 at 1986’s end. In all cases, Materials, Energy and Industrials underperformed, but most Financials did fine.

We expect up S&P EPS in 2015: $120-125 remains our best range estimate

Oil at $65-70/bbl vs. the $80-85/bbl assumed in our 2015E S&P EPS of $123 would likely shave $2-3 from our estimate net of benefits to other sectors. This would be the third cut to our EPS from oil. But, before we cut again, we note the potential for 10%+ EPS growth at Financials, from less litigation net of higher loan loss provisions, at Health Care from strong underlying trends, and Consumer Discretionary and Transports from stronger households and lower fuel costs. If S&P EPS is $117.50 in 2014, inc. ~$2.50 of bank litigation costs, then S&P EPS should be $120+ in 2015 even if oil doesn’t rebound to $80. S&P EPS oil price sensitivity: Oil down $5/bbl from ~$85, hits Energy profits by 10%+, which directly hits S&P EPS by $1.50, or $1 net of benefits elsewhere. S&P EPS FX sensitivity: Every 10% dollar gain vs. the trade basket hits S&P EPS by $2 or 2% or every dime the euro falls from $1.25 hits S&P EPS by $1. Our $123 EPS assumes $1.20 euro, 120 yen, $1.55 GBP on average for 2015.

* * *

All of this, of course, ignores the very real possibility of another harsh winter - because after all, everyone "knows" that the reason the US economy lost over $100 billion in trendline annualized GDP growth in Q1 of 2014 is because of last year's "harsh winter."

So yes, the US may or may not have decoupled from the rest of the world, but just pray it doesn't snow.

As for plunging energy costs, just keep an eye on those earnings warnings by the energy companies due shortly. Once those hit, all of the above will seem, in retrospect, to be painfully obvious.

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kliguy38's picture

but but we're gonna raise interest rates soon.........BWAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA

wee-weed up's picture

if the [crude] plunge is confirmed to be the result of a global collapse in demand

I call bullshit!

Stoploss's picture


They have changed the way GDP is calculated some months back...

So, this comparison is horse shit.


Have a great day.

AldousHuxley's picture

only for Deutschbank's Deutschland since Russian oil oligarchs will stop buying Maybachs.


American Buicks sell well in China.

Atomizer's picture

Deutschbag bank is counting on Diamond rewards card holder points to transfer via gift card to pay off an outstanding delinquent client payout.. FinCen and other public servants are jerking off at the wheel.

Uber Vandal's picture

They will raise the rates the moment Godot arrives, and not a moment earlier.

Ref: Japan.

Caviar Emptor's picture

Unlike Japan, Fed interventions support the quasi-nationalized corporate sector (the 500 or so). Profits or lack thereof won't affect solvency ever again

ebworthen's picture

Yeah, and without stock buybacks it would be even worse.

Go on FED, raise them rates!  Let's get the party started! 

The recovery is here!!!

SpanishInquisition's picture

For comedy gold read this:

The world has the best global ecomony possible plus there's a $1 trillion stimulus from oil prices to boot. Is John Dessauer's real name Pangloss?

Squid Viscous's picture

more doom and gloom, 4.5 years and if the equity mkt gives a fuck about "profits" anymore, if they go down just slap a higher multiple on the pigs...

Tyler do you have an "inguinal crease"?

Caviar Emptor's picture

Just print more oil.
Fixed it

The Most Interesting Frog in the World's picture

And I have been saying for a while, the logical end game to record profit margins, ZIRP, government guarntees, money printing and bail-outs is ultimately ZERO PROFITS.

Money (and I use that term loosely), excuse me, FREE money WILL flow to where it can earn a return.  In fact, the FLOOD of FREE money has been and will continue to flow to "money making" opportunities until the opportunity is GONE.

Take a profitable gas station that operates on a corner.  The government steps in and says, "free money available" and "guaranteed to not lose any money".  Three enterprising business people take the government up on the free "money" and decide to build gas stations on the same corner because the owner of the gas station that is already there is making "so much money".  Oh, the initial "stimulus" is breathtaking.  Construction is back!!!  Full employment!!!  

But, then the construction ends.  The construction workers are laid off.  And, the demand for gas is no higher than before the three additional gas stations were built.  A price war ensues and before long, none of the four gas stations are profitable.

We are in the CYCLICAL "stimulus" phase right now.  When it ends, and it will, there will be a gigantic vacuum on the other side that will make previous collapses look like NOTHING, and will eventually result in RECORD LOW PROFIT MARGINS.  Aint it funny how Adam Smith's invisible hand always wins?

Alea Iactaest's picture

Free money?

Dollar surge endangers global debt edifice, warns BIS

Off-shore lending in US dollars has soared to $9 trillion and poses a growing risk to both emerging markets and the world's financial stability, the Bank for International Settlements has warned.

The Swiss-based global watchdog said dollar loans to Chinese banks and companies are rising at annual rate of 47pc. They have jumped to $1.1 trillion from almost nothing five years ago. Cross-border dollar credit has ballooned to $456bn in Brazil, and $381bn in Mexico. External debt has reached $715bn in Russia, mostly in dollars.

A chunk of China's borrowing is disguised as intra-firm financing. This replicates practices by German industrial companies in the 1920s, which hid their real level of exposure as the 1929 debt trauma was building up. "To the extent that these flows are driven by financial operations rather than real activities, they could give rise to financial stability concerns," said the BIS in its quarterly report.


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Usurious's picture
Usurious (not verified) Dec 9, 2014 8:51 PM



somebody get Robert Triffin on the phone.....

orangegeek's picture

question:  does profit recession = the global economy is a shrinking gong show with markets propped by central banks?


if so, then I agree, profit recession.

Bighorn_100b's picture

Everyone is forgetting about the (ACA) Obama care. Costs more and we make less. How's that for progress.

disabledvet's picture

The new Chevy Volt will be a "killer app" too. All it needs is a place to plug things in while the engine is running and an extension cord "for all the fixins." I mean seriously...that thing will power your house if GM does that.

Once they make a mini bus version...

wrs1's picture

Should be just the opposite for gold miners.  Low oil with stable or rising gold prices should provide good returns.  Of course these are gold mining companies, among the worst run and most corrupt managements in the corporate world.

noben's picture
noben (not verified) Dec 10, 2014 1:05 AM

Lemme see if I got this right:  Real assets, timeless PRIMARY assets like gold, oil, gas, copper and are other commodities are DOWN, but one particular TERTIARY asset (the Dollar) is... UP?

This is notwithstanding that the PETRO-Dollar is created in a computer-based Ledger book (zeros and ones), its supply keeps going UP, and the asset it's attached to is going DOWN.  WTF?  Try following that logic.  And to add to the irony, the US Debt is >$18T and climbing.  And yet, the Dollar keeps going up?

What are the FX guys smoking?  And can I have some of that good shit, which has to be way better than the now legalized pot?

lex parsimoniae's picture

More good news! The falling gas price is translating to an increase in demand for my goods and I would expect most other US manufacturers.

Too bad good news is always presented as a crisis.

Merry Christmas!