Economic Growth & The Stock Market:  Something's Gotta Give

Economic growth and stock performance are closely related.  As economic growth slows, so too do earnings and revenue for companies. This means that as GDP growth decreases, we can expect to see a decline in earnings and revenue for the companies that make up the stock market. And as earnings and revenue decline, stock valuations and prices typically follow suit (though individual companies may buck the trend).

This is the precise scenario many economists predict will play out in 2023.

Earlier this week, the read on Q4 2022 gross domestic product ("GDP") came in better than expected at a 2.9% annualized pace. However, it's important to note that the year-over-year number actually slowed nearly 1%.

To better understand the relationship between GDP growth and stock performance, we can look at the correlation between the two. Economic research firm Hedgeye Risk Management recently published two charts that illustrate this relationship by comparing US GDP growth on a year-over-year basis to S&P 500 sales growth and earnings growth. The first graph compares GDP growth to S&P 500 sales growth, and the second graph compares GDP growth to S&P 500 earnings growth.

GDP growth to S&P 500 earnings growth on a year-over-year basis:

The graphs clearly show that the magnitude and volatility of earnings and sales growth are much higher than GDP growth on an annual basis, but the correlation is still high. As GDP growth trends towards 0% on a year-over-year basis, the S&P 500's sales and earnings growth also follow GDP growth's lead.

CONNECTING THE DOTS...

As of today, with roughly 20% of companies having reported earnings, sales growth has decelerated from over 10% in Q3 2022 to just 5% in Q4 2022. Earnings growth has also slowed, dropping from 3% in Q3 2022 to -2.3% in Q4 2022. Though it is still early in earnings season, the trend is not promising.

Forward estimates for the S&P 500 imply a 10% acceleration in Q1 2023. Given the current Federal Reserve regime, which is still in tightening mode, and the fact that inflation growth remains at historically high levels, it seems unlikely that we will see such a significant jump in earnings. It's clear that something's gotta give.

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