U.S. earnings growth will remain supportive for equity prices this year.
C orporate profits have been the bright spot for the economy. The recovery in corporate earnings has been boosted by a rapid fall in interest costs, a quick reduction in wage rates and a sharp gain in labor productivity.
Although earnings growth will slow as the cycle matures, profit contraction is not in the cards for now. The recent drop in bond yields has pushed real borrowing costs deeper into negative territory, which will benefit the corporate sector. Also, large labor market slack will keep labor costs in check and materials costs have also been lowered as a result of falling commodity prices.
All of these factors could more than offset the negative impact of soft top-line growth, helping keep profit margins high.
While there is growing concern that margins are already high and that “mean reversion” is inevitable, it is important to note that more than 30% of U.S. profits come from abroad and the share continues to get bigger. Yes, corporate margins are at a new high for the current cycle, but are not at a peak relative to long-term history. This is especially true when domestic profits are compared with domestic corporate GDP (rather than overall earnings to domestic GDP).
Cyclically, the market should move in tandem with underlying earnings growth, which our Global Investment Strategy service estimates to be around 6% by year-end. Of course, a much larger price appreciation is possible if multiples begin to expand, but heightened macro risks will limit any meaningful upward re-rating for common stocks.