S&P 500 Vs. NIPA: The Great Profit Debate

Another "who you gonna believe?" moment.

By now, many readers will be aware that SocGen does not harbor a particularly rosy outlook on the global economy for 2020.

Indeed, by the bank’s own admission, their growth outlook is “resolutely pessimistic”.

That’s in no small part attributable to a below-consensus projection for US growth. “The flavour of our analysis is best captured in our forecasts of the developed economies [and] most importantly, our US forecast”, the bank wrote, in their year-ahead outlook piece published late last month.

Read more: Why One Bank ‘Remains Resolutely Pessimistic’ About 2020

Specifically, SocGen sees growth in the US clocking in at just 0.7% next year, well below the 1.8% consensus expects. Indeed, the bank sees a mild US recession in Q2 and Q3.

In the linked post above, we contrasted their call with Goldman’s above-consensus outlook, which calls for the US economy to expand at a 2.3% clip in 2020.

We wanted to briefly expand on the juxtaposition. On Monday, SocGen’s Stephen Gallagher reminded markets that the banks’ recession call “is based on weak profit fundamentals”.

Although he acknowledges that S&P 500 profits “may be stronger than our source–the NIPA accounts–S&P 500 profit expectations are weakening too”.

This is an important distinction, and one that Goldman’s David Kostin took up a few Fridays ago. Here is a truncated version of a much longer rebuttal:

One common pushback to our forecast is that government data paint a bleak picture of corporate profitability and S&P 500 profits may “catch down.” S&P 500 profit margins have risen sharply and are just off all-time highs at 11%. However, profit data based on the National Income and Product Accounts (NIPA) show a different picture with margins declining to 6% in recent years. Reasons we believe these fears are overdone: 1. Size: The S&P 500 comprises large, profitable companies while NIPA data reflects all companies, large and small and public and private. 2. Labor: Due in part to their size and efficiency, labor costs represent a much smaller share of S&P 500 sales than of the broader US economy. 3. Sector: The continued divergence between “superstar” firms – with larger weights in the S&P 500 – and smaller firms also helps explain the margin differential with NIPA. 4. Tax: Following the passage of corporate tax reform, the S&P 500 aggregate effective tax rate fell by 8 pp. Based on NIPA data for the entire US economy, the effective tax rate fell by only 5 pp.

Again, Kostin presents much more detail in the full note, but you get the idea. It wouldn’t be fair to say that Goldman doesn’t take this discrepancy seriously. Rather, they just don’t think it’s likely to derail S&P profits or otherwise have a material impact on their outlook for US equities in 2020.

Getting back to SocGen’s Gallagher, he too cites a number of reasons for the disparity, before ultimately noting that “historically, divergences corrected in favor of the national accounts”.

Regardless, Gallagher cautions that although profit expectations always (or almost always) come down over the course of a year, “this fading has been more extreme in recent quarters”.


As you can see, profit expectations have needed to come down much further than “normal” in order to engineer the customary beats during earnings season.

You’ll recall that earnings growth turned negative in Q3 for the first time since 2016 (in red).

(Q4 EPS growth is estimated, SPX return is QTD through Dec. 16)

Ultimately, this debate (i.e., the “who you gonna believe” between NIPA and S&P 500 earnings) won’t be settled for months.

But it’s worth remembering that margins are likely to come under more pressure going forward thanks to rising input costs and wage inflation.

“Companies have little or no pricing power and costs, particularly labor costs, are climbing”, Gallagher goes on to say. “As a result, profit margins are shrinking and we do not see this environment improving, even with a trade deal”.


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