Our discussions have included Fed policy, the economy, and the surge in inflation since the pandemic. Why? In large part, they are all a part of the stock market pricing equation.
Yet, so are corporate profits, and profits for the largest U.S.-based companies are heavily influenced by economic activity.
Undoubtedly, there are a few companies that execute well in most environments, while others reside in industries that are more resilient to economic downturns.
However, most companies in the S&P 500 rely on a stiff tailwind from economic growth. And when an economic downturn eventually occurs, profits in the S&P 500 turn south.
A recession has yet to happen, but when it occurs, profits fall, as we experienced in the 2008-09 and 2020 recessions.
A numerical review
With 95% of S&P 500 companies having reported in Q3, S&P 500 profits are projected to rise a solid 8.9% compared to one year ago, according to LSEG. That is up from a 5.3% forecast as of October 1.
Typically, projections rise through the quarter as firms, on average, typically top conservative forecasts.
More impressively, 76% of S&P 500 firms that have reported have beaten the consensus profit forecast, which compares favorably to the long-term average of 67%.
And there’s more. Companies that top profit estimates are beating by a wider-than-average margin in Q3: 7.6% versus the historical average of 4.2%.
A strong reason for Q3’s upbeat performance is technology, which is projected to rise by 19% in Q3.
Bottom line
Over the medium and longer term, the economy is a significant underlying support for corporate profits. Put another way, rising corporate profits have historically been a magnet for investor cash over the longer term.
When the economy is expanding, companies, individuals, and families buy more ‘stuff.’ And it is that stuff (goods and services) that drives profits. It’s not a one-to-one relationship, but it is a significant driver of earnings.