US Profit Growth Is Negative For All But The Largest Companies

Yesterday when looking at the rolling forecast of Q3 earnings season, we noticed something remarkable: according to Bank of America, while overall Q3 earnings growth was expected to be a modest 4%, this would be entirely due to a 19% increase in Mag 7 earnings (down from 37% in Q2 and down from 55% a year ago). The rest of the S&P500 - some 493 companies - are expected to post another quarter of flat earnings!

This stunning lack of earnings growth for all but the largest US companies is visualized in the next chart:

In other words, for all the talk about robust earnings growth, if one takes away just 7 companies which make up the apex of the AI bubble, and.... there is no earnings growth at all.

We decided to dig a little more into this and found just how deep this rabbit hole goes.

In a recent note from SocGen's Albert Edwards (available to pro subscribers), the resident bear was ruminating on "how the US economy had managed to remained surprisingly resilient "confounding economists’ predictions that it would slide into recession last year."

Edwards goes on to note that while most economists will focus on the perennial resilience of the consumer as a reason for GDP upside surprises, "others such as myself believe that surprising robust US profits hold the key to the business cycle." He then goes on to note that whole economy profits tend to lead the economic cycle: "Profits declines typically occur before a recession as they force corporate to cut back on business investment (including inventories) and job hiring. A profits decline usually precedes an economic downturn."

On the other hand Any downturn in profits is not immediately visible at the stockmarket level as finance directors have ample (legal) ways to ‘massage’ pro-forma earnings higher. As such Edwards' preferred representation of corporate profits comes from the whole economy profits data set published by the BEA as part of the GDP release are derived from IRS tax data, which are a far more accurate representation of what is happening under the hood (companies might try and fool the market but not so much the IRS).

Needless to say, a decline observed in the whole economy profits typically precedes a downturn in stockmarket profits as it also precedes a recession.

And it is here that we find something stunning: as Edwards shows in the "incredibly important chart below", as we noted above, aggregate profits data (including the whole economy profits) are being inflated higher by a small number of large and mega-cap stocks. Looking at the large cap S&P 1500 universe, if one excludes just the top 10% of companies profits are flat. And If you exclude the top 50%, then profits are falling sharply. This story is confirmed by the Russell 200 small cap stocks and the small unquoted companies surveyed by the NFIB.

To be sure, as Edwards discussed above, robust US profits have been a key reason why the corporate sector was able to maintain its spending on jobs and investment. Remarkably, profit margins surged higher in the wake of the pandemic, even as unit costs also jumped higher. This, according to the Socgen strategust, was unprecedented:  rising unit costs had always previously led to falling margins: "Call it what you like, this was a key reason why the US avoided recession."

Yet the granular aggregate profits chart shows above, we now know that only a handful large and mega-cap companies have been driving this rosy aggregate profit picture. Yet, because it is small companies that drive employment growth, not the large and mega caps, the US economy could still be vulnerable to recession as ‘long and variable’ monetary lags work through the system, especially once the true - and truly gruesome - employment picture is revealed after Trump wins the election in three weeks. We got an early glimpse a month ago when the Biden BLS decided to erase some 818,000 historical "jobs"; take a wild guys how many "excel spreadsheet" jobs will be deleted once the deep state apparatchiks no longer have an incentive to put lipstick on this pig of an economy...

Until then, however, consider this: Jeff Snider recently noted that in Jan 2001 - just before the recession - the BEA reported payrolls had risen a similarly robust 268k. The equity market rejoiced as the Fed had also just cut rates for the first time that month. But just two months later a recession started and subsequently that large Jan 2001 rise was revised to a decline! (A similar thing happened with the robust 166k rise in Oct 2007 payroll data, just two months before a recession began.)

As Edwards puts it all together, "the payroll data are lagging, unreliable and will be revised", especially now that it has become nothing more than a political propaganda tool.