(Bloomberg) — For all the warnings from the bears that the plunge in profits is proof that U.S. stocks have nowhere to go but down, not so fast.
Buried deep in a routine Federal Reserve report that is notable mainly for its numbers-heavy presentation is a data point that threatens to upend the notion that Corporate America is struggling to boost earnings. The Fed’s measure of income, which happens to have moved in unison with profits for Standard & Poor’s 500 Index companies 83 percent of the time since 1992, just posted its biggest quarterly increase since 2012.
Strength in the Fed data contrasts with earnings viewed through the benchmark equity measure, where analysts are predicting the largest quarterly contraction since 2009, based on data compiled by Bloomberg. The divergence highlights what bullish investors have said is an illusion of weakness in profit signals flashed by stocks, where the biggest drop in oil-company earnings since the financial crisis is drowning out strength elsewhere.
“I simply don’t see U.S. corporate earnings peaking — quite the contrary,” said Ross Yarrow, director of U.S. equities at Robert W. Baird & Co. in London. “The S&P 500 is too narrow to show the true health of corporate America. It’s too skewed. Lower oil prices feed into so many raw-material costs, and that is very, very good for the rest of U.S. corporates.”
Any indication earnings aren’t cratering would be welcome in a U.S. stock market that just posted its worst quarterly loss in four years. Since the middle of August, investors have watched as volatility jumped on concern the global economy is weakening just as China slows down and the Fed prepares to raise rates. Worries about future profit growth have worsened sentiment.
The indicator cited in the Fed report tracks “Nonfinancial Corporate Business” profits before taxes. In the three months through June, those climbed 11 percent year-over-year, the most since the fourth quarter of 2012. That compares with a retreat in S&P 500 income of almost 2 percent, data compiled by Bloomberg show.
Comparing the two earnings gauges isn’t apples-to-apples: the Fed’s looks at pretax profit for non-financial companies throughout the U.S. The S&P 500’s measures after-tax income for a smaller subset of corporate America and captures roughly 75 percent of the nation’s equity market cap. At the same time, the two have moved in virtual lockstep on a yearly basis, with weakness in the Fed index portending a shrinking economy in 2001 and 2008.
The U.S. benchmark index rose 1.8 percent at 4 p.m. in New York, capping a five-day advance that’s the longest this year.
That’s not happening now. In fact, according to Goldman Sachs Group Inc., the plunge in oil is masking a U.S. profit picture that if anything is unusually healthy. Earnings before interest, taxes, depreciation and amortization make up about 17 percent of U.S. gross domestic product now compared with 15 percent during the 2001-to-2007 expansion, analysts led by Francesco Garzarelli, the firm’s co-head of macro markets and market research, wrote in a Sept. 30 note to clients.
One reason is that zero-percent borrowing costs are holding interest expenses down and boosting cash flow, Garzarelli wrote. While Friday’s employment report showed U.S. payroll growth trailed economists’ forecasts by 29 percent and sent the S&P 500 down as much as 1.6 percent, it also pushed back expectations for a Fed interest-rate increase until at least March, financial futures showed.