Editor's note: As usual, the latest "recession" buzz is more complicated than it seems... So today, we're sharing another piece from Joel Litman, chief investment strategist at our corporate affiliate Altimetry. In this essay, adapted from the Altimetry Daily Authority, Joel sheds light on what most people don't know about the fall in corporate earnings... and how you can protect your portfolio.

U.S. corporations made too much money last year...

Our economy has spent much of 2022 digesting higher prices due to inflation. And the effects have started to show up in recent quarterly earnings.

As I recently shared in the Weekend Edition, big banks Morgan Stanley and Goldman Sachs are concerned that we're on our way to an "earnings recession." That happens when corporate earnings fall for two consecutive quarters.

News outlets have started to echo this worry. But being in an earnings recession doesn't mean that our economy is in an actual recession.

To understand why, you have to consider the factors that are weighing on earnings. One well-known factor is the Federal Reserve and its interest-rate hikes. The central bank is doing all it can to slow inflation, and that's cooling down the economy.

But there's another key reason for this downtrend. I'll share what it is today, and more important, I'll discuss what investors should do to protect themselves...

As Morgan Stanley explained, companies over-earned in 2021.

Last year, government stimulus packages and a historic rise in consumer demand caused earnings to soar. This situation is a lot like what happened in 1945...

As the world recovered from World War II, soldiers returned home and started families. Demand for consumer goods skyrocketed, pushing corporate America's operations to unsustainable levels.

Gross domestic product ("GDP") in 1946 surpassed what should have been possible. So it made sense when earnings fell back to normal levels in the following years.

We've been experiencing the same thing today. As the world moves on from pandemic restrictions, demand has been soaring.

The Fed is trying to slow demand in hopes that inflation will follow suit. And while this is in the economy's best interest over the long term, it will hurt near-term company earnings...

Higher interest rates have discouraged consumer spending and corporate borrowing. Meanwhile, inflation has remained high. Many economists argue that higher costs for raw materials and rising wages are cutting into corporate profits. This will bring corporate earnings back to their longer-run averages as a share of GDP.

In short, after 2021's unsustainable boom, earnings are beginning to fall back to Earth.

At the start of the year, as-reported trailing 12-month ("TTM") earnings per share ("EPS") for the S&P 500 grew. They increased from $197.87 in the fourth quarter of 2021 to $197.91 in the first quarter of 2022. That's a paltry four cents – and only 0.02% higher.

But if that initial slowdown felt bad, the second quarter has been far worse...

More than 99% of companies have reported second-quarter earnings. Earnings dropped almost 3% from the first quarter, down to $192.32.

This is the first S&P 500 earnings dip in the past six quarters... since the midst of the pandemic.

And third-quarter estimates don't look any better. Earnings are forecast to drop another 0.5% to $191.25. Wall Street analysis expects this decline to continue through the end of the year, bottoming at $188.20 before recovering in the first quarter of 2023.

With earnings looking rudderless, many are concerned about what it means for the market...

But that's not what you should be focused on. It doesn't matter whether earnings return to growth this quarter or next year – we know this situation will even out in the end.

What matters is this: Even when overall corporate earnings show weakness, that doesn't mean every part of the economy is struggling...

The S&P 500's second-quarter fall was largely driven by the consumer discretionary and financial sectors. TTM consumer discretionary earnings were down $3 in the second quarter of 2022. The financial sector's earnings have dropped a staggering $13 since the fourth quarter of 2021.

These two underachievers dragged the entire index down. But some pockets of the market were stronger... The energy sector's TTM earnings increased almost $20 from the first quarter of 2021. Health care earnings rose $2.

Even an uncertain market breeds opportunity.

It's hard not to focus on the direction of the market as a whole – especially when that's all the mainstream financial media can talk about.

And yet, whether you're investing in an up market... a down market... or a sideways market... there's always a way to make money if you look in the right places.

Regards,

Joel Litman

Editor's note: Joel believes that what's coming next will trigger huge investment gains – and catastrophic losses – by the end of the year. That's why TOMORROW, at 8 p.m. Eastern time, he's teaming up with Marc Chaikin of Chaikin Analytics for an urgent online event... to share what might be the boldest prediction of their careers.

They'll reveal why the weeks ahead could determine your wealth for the next decade. Plus, you'll learn the names and ticker symbols of two incredible opportunities – as well as two stocks that could fall to zero in the coming weeks. Save your spot for this free event right here.