When the results come in, US economic growth and earnings are on pace to show very different grades.
Gross domestic product is forecast to grow 1%, according to Bloomberg’s estimate for the advance reading expected on Friday.
But earnings per share for S&P 500 corporations is expected to do much better, up by 15% year-on-year, according to Deutsche Bank.
Ultimately, this divergence is a reminder that what impacts the stock market does not necessarily have a run-off effect on the economy. And because they are calculated differently, this kind of contrast is not out of the ordinary, said David Bianco, the chief investment strategist for the Americas at Deutsche Asset Management.
“Many cite the high correlation of S&P EPS and nominal US GDP growth year-over-year, but this is only strong in a cyclical sense,” Bianco wrote in a note.
“Outside of recessions, S&P EPS can vary from negative to double-digit growth rates when US GDP is anywhere between 2-4%. Outside of recessions, it is global growth, investment spending, US exports/global trade, commodity prices, FX rates, loan growth, and non operating factors like taxes, acquisitions, buybacks, and other reinvestment that drives S&P EPS growth.”
One difference between both is in how they are calculated. GDP growth is measured quarter-on-quarter at a seasonally adjusted annual rate and is adjusted for inflation. However, EPS is unadjusted for inflation, and measured year-on-year.
Further, earnings are calculated only when a company has actually completed an order or transaction. But GDP is measured on a current-production basis. “This means that inventory accumulation adds to GDP, but not profits, and that investment capex adds to GDP, but doesn’t reduce profits,” Bianco wrote.
As much as two-thirds of economic growth depends on consumption, while earnings are more influenced by manufacturing and business investment.
Also, S&P 500 earnings are more sensitive to global growth than US GDP is, because of the impact that foreign exchange rates have on multinationals.
The economy certainly matters very much to earnings, especially for companies that earn most of their revenues in the US. And, financial markets, reflecting confidence levels and expectations for future earnings, tend to lead economic growth and downturns.
“We believe acceleration and reflation expectations got overdone, but we still see an extended cycle of moderate growth that is conducive for economic profit growth, particularly for growth stocks,” Bianco concluded.