Corporate profits

Corporate profits are not keeping up with inflation, a warning sign

The US stock market is booming, with the S&P 500 up more than 3% this week and nearly 25% for the year. Fears over the Omicron variant of the coronavirus quickly subsided, with stocks regaining lost ground.

That’s making some market watchers nervous, reports the DealBook newsletter, because of a metric that suggests stock prices may be too high given the level of corporate earnings and rising inflation. On Friday, the government announced consumer prices rose 6.8% in November from a year ago.

The S&P 500 now has a real earnings yield — the inflation-adjusted ratio of earnings per share to stock price — of minus 3.5%, and is now the lowest since 1947, the strategists wrote in Bank of America shares led by Savita Subramanian in a recent note to clients. Negative returns are rare and often precede a stock market crash, the analysts wrote.

Poor earnings performance means corporate earnings are not keeping up with stock prices. And because real returns subtract inflation from the measure, a negative real earnings return means that a company, based on its stock price, is not generating enough profits to keep up with rising prices. (Tesla’s actual earnings yield is negative 6.3%.)

According to Bank of America analysts, the last time the S&P 500 posted a negative real earnings return was in 2000, before the bursting of the tech bubble. It also happened twice during the stagflation of the 1970s and 1980s. This year, the real earnings yield of the S&P 500 turned negative months ago, but it really fell recently as inflation rose. .

Besides a bear market, there are two ways a negative return can turn positive:

  • First, inflation should come down significantly, which some economists believe is possible.

  • Second, corporate profits, at a time when wages are rising and supply issues are interfering with plans, could accelerate faster than expected.

After the initial shock of the pandemic, stocks shrugged off negative news and set a series of record highs. But the more analysts consider the numbers, the more they fear the gravity-defying rise may not last much longer. (The shares fell on Thursday.)

That said, “we live in a world where true negative rates are almost acceptable as the norm,” Ms. Subramanian noted.