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Earnings recession may not be dire for stocks

A trader works on the floor of the New York Stock Exchange.
Adam Jeffery | CNBC
A trader works on the floor of the New York Stock Exchange.

Earnings recessions without a full-blown economic recession are a rarity, but if history is a guide it does not necessarily have to be a negative event for the stock market.

As the outlook for first-quarter growth looks gloomier, traders are concerned about the fact that profits for the quarter are expected to show the first decline since 2009. According to Thomson Reuters, S&P 500 net income is expected to fall by 2.7 percent.

Read MoreU.S. economy stalled in first quarter

Morgan Stanley Chief U.S. Equity Strategist Adam Parker released a report Monday on past earnings recessions and points out there have only been three since 1974 where net income declines were not associated with an economic recession. Each time, the S&P improved in the year prior to the decline, and also rose from the beginning to the end of each of the three periods.

Economic growth is sluggish but has not contracted as it did in the first quarter of last year so a recession is not now in the cards. Economists expect growth of 1.4 percent, according to the latest CNBC/Moody's Analytics rapid update.

Stocks have been choppy but flattish for the first quarter, and the S&P 500, up more than 1.1 percent Monday, is now up about the same amount for the entire first quarter.

"We see modest upside leading into Q1 earnings season given once again lowered expectations and continued negative guidance," wrote Parker. "Investors remain focused on the dollar and oil, but we see modest EPS growth by year-end as likely."

Parker, in a note, said that S&P performance after the three earnings recessions was generally strong, albeit a small sample.

In the first instance in 1986, there was a decline a year later, due to the Black Monday crash in 1987. But the other two periods—1998 and 2012—where net income declined and there was no recession, the S&P rose respectively by 6 percent and 22 percent, four quarters later.

Read MoreCramer: Weak earnings led to dud Q1

"While this is obviously a small sample size, the notion that an earnings recession without an actual recession is definitively bad for the market isn't actually borne out by these data," he noted.

Morgan Stanley analysts are also watching out for corporate comments regarding the impact of the stronger dollar and falling oil prices, and what they may mean for costs and growth prospects in coming quarters. The dollar and oil are most blamed for anticipated shortfalls in the profits of companies with overseas sales and energy companies.

The S&P profit outlook would be a positive gain of 5.5 percent, if the decline in energy profits were excluded for the first quarter, according to Thomson Reuters.

The Morgan Stanley analysts note that over the last three months, the consensus estimates for the first quarter were cut in 9 out of 10 major industry sectors. Estimates for the full year are down 8.1 percent, in large part due to energy. They also note that companies have been offering negative guidance on a ratio of more than 5-to-1.

Morgan Stanley's full-year EPS forecast is now $124, and the analysts note that for the first time, their full-year top-down estimate is above the Street's bottom-up consensus estimate at this point in the year. The consensus is now $120.