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Talley Léger | May 4, 2022

Where are we in the U.S. corporate profit cycle?

Equity strategist Talley Léger discusses one of his preferred gauges for assessing where we are in the U.S. corporate profit cycle — and what it’s telling investors today.

As my regular readers know, I’ve been bullish on U.S. earnings for over a year (and bullish on U.S. stocks for even longer), and I believe that has been the right view. But where are we in the U.S. corporate profit cycle today? Has the fundamental outlook changed?

The Institute for Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) is one of my preferred gauges for assessing where we are in the U.S. corporate profit cycle. The ISM PMI is a direct measure of expectations captured by business surveys of production and the general economic climate in the U.S. More importantly, as shown in Figure 1, this sentiment indicator has helped to foresee earnings trends roughly half a year in advance.

After correctly signaling a V-shaped earnings recovery, U.S. manufacturing activity now suggests that peak earnings growth is likely behind us. Looking ahead, softer output suggests we may see slower but still robust earnings growth in 2022 (Figure 1).

Figure 1: U.S. manufacturing activity suggests peak earnings growth is likely behind us

U.S. manufacturing activity (pushed forward half a year) and earnings growth (up/downside thresholds) since 1990

Sources: Bloomberg, Institute for Supply Management, Standard & Poor’s, Invesco, 4/1/22. Notes: PMI = Purchasing Managers Index. EPS = Earnings per share. NBER = National Bureau of Economic Research. Shaded areas represent NBER-defined U.S. economic recessions. A correlation coefficient measures the strength of the relationship between the relative movements of two variables. The values range between -1 and 1. A perfect positive correlation is 1, and a perfect negative correlation is -1. There is no guarantee the forecast will come to pass. An investment cannot be made in an index. Past performance does not guarantee future results.

Where are we in the U.S. market cycle?

Historically, investors have been amply rewarded by simply sticking to stocks in periods when earnings growth was positive, as it is now. While I believe stocks remain the place to be amidst a moderating economy, peak earnings growth should compel investors to lower their expectations for absolute returns. In other words, I expect U.S. stocks to continue doing well in 2022, just probably not as well as they did in 2021 and 2020 (Figure 2).

Figure 2: U.S. stocks did best during periods of positive earnings growth

U.S. stock market returns during periods of positive (white) and negative (gray) earnings growth since 1990

Sources: Bloomberg L.P., Standard & Poor’s, Invesco, 12/31/21. Notes: Y/Y = Year-over-year. *S&P 500 % change = Compound annual growth rate (CAGR). Shaded areas represent periods of negative earnings growth. White areas represent periods of positive earnings growth. An investment cannot be made in an index. Past performance does not guarantee future results.

Click here for more visual guidance on equity portfolio positioning in slowdown, U.S. Federal Reserve tightening, and inflation regimes.

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Some references are U.S. centric and may not apply to Canada.

Commissions, trailing commissions, management fees and expenses may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the simplified prospectus before investing. Copies are available from your advisor or from Invesco Canada Ltd.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.

All investing involves risk, including the risk of loss.

Past performance is not a guarantee of future results.

An investment cannot be made directly in an index.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

The opinions referenced above are those of the author as of April 10, 2022. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.