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Corporate profits and economic growth are divergent. That’s great news for stocks.
Reuters
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An ideal setup for the stock market has emerged as profits grow and the economy slows, Bank of America says.
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The bank said this rare configuration – seen just 11% of the time – delivers outsized gains for stocks.
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“The divergence comes primarily from improving production versus slowing services,” BofA said.
The stock market has entered an ideal environment to generate more gains as economic growth slows and corporate profits continue to rise, Bank of America said this week.
Bank of America Analysts highlighted in a Tuesday note that this ultra-rare scenario, which has happened just 11% of the time since 1950, tends to deliver outsized gains for the stock market.
When earnings per share grow and GDP growth slows, the S&P 500 has historically delivered average quarterly returns of 3.6%, for a win rate of 79%.
Those average returns fall to 3% at a 63% earnings rate when earnings growth is falling and the economy is growing, and they fall to 2% at a 62% earnings rate when both earnings and economic growth are falling. are falling. And when both the economy and corporate profits are rising, the S&P 500 delivered an average quarterly return of 2% with a win rate of 69%.
The bank said Evidence continues to mount that GDP growth will be revised downwards, as activity moderates and the job market slows down. At the same time, the bank predicts an acceleration in corporate profits, with earnings per share growing 3% in the last 12 months.
“Historically, a scenario of slowing GDP + accelerating earnings per share has been the best macro environment for stocks. The divergence comes mainly from improving production versus slowing services,” said Bank of America. “With an industrial recovery underway, improving fundamentals should continue to support the market.”
The bank added that companies have plenty of operational leverage to draw on, which should mean higher gross margins and therefore higher corporate profits, even if economic growth continues to moderate.
Read the original article at Business Insider