The question is how sustainable these re-cord profits are because of the continuing crisis in the eurozone.
The impact of the austerity measures on the European Union economies could be severe. Nearly 50% of euro¬zone GDP comes from government spending, which is almost double that of the US. As country after country in the eurozone cuts spending fur¬ther, the odds of EU GDP turning negative increases.
A European recession would clearly hurt US exports to Europe, but the US economy is not overly exposed as the EU only represents approximately 20% of the total US export market. Demand growth in the emerging markets should help to counteract any downturn in Europe. Moreover, the strength of corporate balance sheets in the US should help to alleviate the potential impact of any tightening of global credit caused by a more restrictive lending environment in Europe.
On US corporate profits, historically S&P 500 earnings have grown twice as fast as GDP. In 2011 S&P 500 earnings rose a remarkable 15% while GDP expanded just 1.4%.
US corporations have generally delivered exceptional numbers by squeezing every last dollar they can out of sluggish sales through tight cost controls. Of course the focus on profits has kept a lid on new hiring, leaving the unemployment rate at around 9%. The pre-tax margin for S&P 500 companies has gone from 4.4% during the recession of 2008 to 12%.
The frustration last year was the dichotomy between the macro and micro data. While many companies reported stable demand and business fundamentals, these attributes mattered little when the market was fixated on the European debt crisis and fragile global recovery. Volatility and thematic investing were the trends last year.
However, equity valuations are relatively compelling, even if the growth of corporate profits moder¬ates. The S&P 500 is currently trading well below its five, ten and 20-year price/earnings averages so there are certainly reasons to be optimistic for the US despite the chaos overseas.
