Our July Quarterly Commentary, released last week, highlighted that U.S. corporate earnings peaked in 2018’s third quarter. GDP data announced Friday indicated that second quarter corporate profits posted their largest annual decline in several years. Q2 marked the third consecutive quarterly decline, off 7% from year ago levels. In the annual GDP revisions, operating profits were lowered by significant amounts for both 2017 and 2018. According to the GDP data, there has been no growth in U.S. operating profits for the past five years. Remarkably, the S&P 500 has advanced by over 50% during the same time period. The Fed’s newly created money has obviously found its way into stocks and bonds, not into the economy, ostensibly the target of the Fed monetary policy.
Economic and corporate profit growth have been similarly sluggish in most of Europe, but European stocks have shown a far more logical relationship to the weak underlying fundamental conditions. Stocks surged when the European Central Bank (ECB) initiated its Quantitative Easing (QE) policy in early 2015, but, unlike in the United States, stock prices subsequently reflected weak economic conditions rather than central bank stimulus. The Stoxx 600, a broad European index, is 6% lower today than in April 2015.
The Fed, ECB and other major central banks are now expected to employ looser monetary policies beginning this week. Even factoring in that expectation, the vast majority of economists anticipate both 2019 and 2020 to show weaker economic growth than 2018. Last Thursday, Reuters announced the results of its poll of over 500 economists taken this month. The growth outlook for nearly 90% of almost 50 world economies was either downgraded or left unchanged for both this year and next. In answer to a separate question, over 70% of about 250 economists now anticipate a deeper global downturn than they previously expected.
If these economic forecasts prove accurate, the question facing investors is whether stock prices will nonetheless advance because of central bank stimulus, as they have for years in the U.S., or decline in concert with fading economic conditions, as has been the case in most of the rest of the world.