By: Editorial Team, StoneX Media
With the S&P 500 stacking up 31 record highs in a single year against live conflicts, policy rate uncertainty, and rising commodity prices, investors face an obvious question about what is holding the rally together. The corporate profit cycle, the year-over-year growth in corporate earnings that has historically rolled over before recessions, is the measure carrying the answer. Profitability fell in advance of the past two organic recessions, and only the COVID-19 shutdown broke that sequence. That history is why the direction of corporate profits now functions as the stock market's risk barometer.
A CFA charterholder since 2002, Michael Lytle is Chief Investment Officer at StoneX Wealth, where he leads the portfolio management process across managed portfolios of mutual funds and exchange-traded funds and individual portfolios of stocks and bonds. His work centers on broad asset allocation across equities and fixed income, the exact decision a turning profit cycle would force.
Year-over-year growth in corporate profits carries a track record that gives the current reading its weight. Reviewing the profit cycle against past downturns, Lytle notes that "the first two saw profitability fall even in advance of the recession" [00:55], with the COVID-19 shutdown the only break in the pattern because the economy was closed by policy rather than falling on its own. The signal is not evenly distributed, since "massive amounts of money being generated in some of the larger cap technology companies" [00:43] dominates the aggregate. Consequently, that history turns a single chart into an early warning indicator for both the economy and equity positioning.
"As long as corporate profitability continues in this trend, there's more room for stocks to run in this environment," [01:10] Lytle says. The list of challenges is long, from uncertainty over policy rates to commodity prices rising on the conflicts in the Middle East and the war between Russia and Ukraine, yet markets and profitability are looking through all of it. That resilience turns the profit trend into a working decision rule rather than a talking point. "Any pivot in this would definitely inform our willingness to continue to take risk at the level that we are today," [01:36] he adds, making the chart the line between holding risk and reducing it.
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--- Written by Gus Farrow, Senior Manager, StoneX TV
--- Expert: Michael Lytle, Chief Investment Officer, StoneX Wealth
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