How does GDP growth affect corporate earnings?

Ongoing discussions about the risk of recessions have sparked inquiries into the correlation between economic growth and corporate earnings. Faced with this, Schroders delves into the differing relationships between the two. 

“When an economy is performing well, consumers often spend more, and business activity increases. As a result, corporate profit margins improve, leading to higher earnings growth. Conversely, during recessions when demand is weak, earnings growth typically turns negative,” writes Tina Fong, Strategist at Schroders. 

However, Schroders points out that the relationship between earnings per share (EPS) and gross domestic product (GDP) growth is not flawless. Fong contends that the composition of the stock market and corporate earnings may not accurately represent the overall economy, as seen in European markets compared to the more representative US market.

Also, the widely-used EPS metric has limitations, especially in emerging markets, where companies needing capital may dilute EPS by issuing more shares, she adds. Furthermore, the impact of revenues and earnings generated by stock market-listed companies may be driven by overseas growth rather than domestic economic conditions, asserts the asset manager. 

Shorders informs that countries like China and Brazil rely more on domestic sources, while the UK and German stock markets host multinational companies, with a majority of revenues coming from overseas.

Separately, the asset manager talks about the impact of new globalisation trends. “With the re-wiring of globalisation, some countries – particularly in the emerging world – are likely to be the key beneficiaries of changes in supply chains,” says Fong. 

She adds that in the US, a potential reshoring trend could result from the “3D Reset,” involving deglobalization, demographic shifts, and decarbonisation as significant drivers of economic activity over the medium term.

“For other countries, these changes might increase the importance of the overseas activities and the profits being repatriated, which may not be reflected in the domestic GDP,” elucidates the asset manager. 

Read the full insight here.