October 25, 2023
Corporate earnings are a fundamental driver of equity markets. While the direction of equities can be influenced for a short time by movements in market multiples – such as the price-to-earnings (P/E) ratio – earnings growth seems to be a better signal of the long-term trend in these markets. Thus, understanding where earnings are headed is key to the outlook for equity markets.
Earnings tend to follow the economy. As shown in the chart below, earnings and gross domestic product (GDP) typically grow in the same direction. In this case, we are using the S&P 500® Index earnings forecasts for the next 12 months. As GDP growth increases, earnings growth typically moves higher. The same is true when the economy enters a recession, with weak GDP leading to weak earnings.
One detail worth highlighting is that earnings growth tends to be more cyclical than the economy, shown in the different scales in the chart. Since 2000, the average change in next-12-months (NTM) earnings growth is nearly 3.5 times GDP growth. In other words, earnings growth is a leveraged play on GDP growth.
We have consistently expected the US economy to fall into a recession. If this forecast is ultimately accurate, corporate earnings could be at significant risk.
US GDP and corporate earnings growth
Year-over-year change, 2000-2023
Note : Shaded areas of chart indicate recessionary periods.
Sources: Macrobond, S&P Global, US Bureau of Economic Analysis (BEA).
Chart is for illustrative purposes only.
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