Third quarter earnings season is off to a good start, and we expect the good news from corporate America to continue throughout the reporting season, despite the narratives out there in the media about peak earnings and the risks surrounding the U.S.-China trade dispute. We do not want to be dismissive of the trade risk, and we acknowledge earnings growth is slowing, but we believe the economic fundamentals are healthy enough to offset the impact of tariffs. And there is a long way to go from low- to mid-20s earnings growth rates that we are seeing now to the long-term average earnings growth rate for the S&P 500 Index in the 7–8% range. “We think it’s too early to worry about peak earnings,” notes LPL Chief Investment Strategist John Lynch. “Corporate fundamentals look quite good and the U.S. economy is on solid footing.”
So how does a healthy U.S. economy translate into corporate profits? One way is through the relationship with nominal gross domestic product (GDP), which includes inflation. As the LPL Chart of the Day illustrates, annual growth in the U.S. economy correlates well with S&P 500 revenue growth. Revenue is particularly important for profit growth at this stage of the business cycle when companies have a difficult time expanding profit margins. Not only is nominal GDP rising at a solid 5–6% pace year over year, it is accelerating and should continue to benefit from fiscal stimulus for at least the next several quarters. Further, earnings tend to follow manufacturing activity, which is quite strong currently. Bottom line, the earnings outlook is quite positive.
Look for more details on earnings results so far and what to watch in this week’s Weekly Market Commentary due out later today. You can also follow earnings season in our Earnings Season Dashboard, which we plan to update each week for the next five weeks.
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