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

May 4, 2022

2 minute read

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