If you want to know how well the U.S. economy is doing, don't look at the stock market.
While aggregate operating earnings among the S&P 500 have surged nearly 40% from the beginning of 2016 to the first quarter of 2019, profits across corporate America as a whole grew by just 1%, according to calculations by research group Capital Economics, citing National Income and Product Accounts data.
Typically, the two measures are in virtual lockstep with any divergence swiftly eradicated. The last time they were this far apart was the height of the financial crisis when the nation's largest companies were hit much harder than their smaller peers.
The disconnect between the two is "unsustainable," John Higgins, chief markets economist at Capital Economics, wrote in a research paper. "Despite the puzzling surge in S&P 500 EPS in recent years, we don't expect it to last and think that investors' lofty expectations for them will be disappointed."
To get back in line with the underlying economy, the S&P 500 index will probably need to fall about 15% from its current levels to about 2,500 by year-end, he said.
Analysts studying the most recent earnings season could be forgiven for concluding that corporate profitability has remained robust in the face of an escalating trade war and a slowing global economy. Of the 451 S&P 500 companies to report second-quarter numbers, 74% beat expectations, while EPS for the S&P 500 has recorded a surprise of 17.8%.
That contrasts with a $59.3 billion (2.6%) drop in first-quarter profits among U.S. businesses as a whole, following a $9.7 billion decline in the fourth quarter of 2018, led by nonfinancial domestic industries, according to the Bureau of Economic Analysis.
The large-cap public companies that make up the S&P 500 are not typical U.S. corporates. They are also tilted toward specific sectors, such as IT, which have led the charge in equities in recent years.
"To get into the index you have to — hopefully — be profitable, so it's not always going to correlate with the economy; it'll correlate more closely to the market," said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
The Bureau of Economic Analysis revised down U.S. corporate profits by $200 billion over the past three years due to increased labor costs and interest payments on debt.
The performance is worse for domestically focused companies, for which profits fell 3.6% in the first quarter, while profits from the rest of the world rose 1.5%.