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Investors Need To Pay Attention to the CBO

Keith Hall, Director of the Congressional Budget Office (CBO), arrives to testify about CBO's Budget and Economic Outlook for Fiscal Year 2019-2029, during a Senate Budget Committee hearing on Capitol Hill in Washington DC on Jan. 29, 2019.Saul Loeb—AFP/Getty Images

When most of us hear forecasts for future profits, the source is generally the latest survey of securities analysts conducted by such prominent data and analytics outfits as S&P and FactSet. The Congressional Budget Office meanwhile is a fount of prognostication, but it doesn’t predict earnings for America’s big companies. So it’s remarkable that investors can get a better view of where profits are headed by following the CBO’s big-picture outlook for the U.S. economy than banking on Wall Street.

Today, the banks’ “consensus” forecasts assembled for 2019, and the the CBO’s projections for GDP growth, are diametrically opposed. In the most recent FactSet survey, issued on February 4, the analyst community forecasts earnings-per-share growth of 5.3% for 2019. That scenario sounds middling, but keep in mind that EPS jumped an estimated 20.2% last year, so climbing from those heights by adding 3.3% in “real,” inflation-adjusted gains would plant the flag on another banner year.

The best bet is that earnings won’t reach a new mountaintop, or even come close. The forecasts of when those projected gains will arrive as the year progresses, and CBO’s view that the economy will wane just when earnings are supposed to jump, renders the big banks’ widely cited projections a fantasy. The FactSet poll foresees zero EPS growth in Q1, followed by a 1.9% gain in Q2 and 2.6% in Q3, for an average annual rate of 1.5% over the first 9 months of 2019. But Q4 is supposed to bring an extraordinary reversal of fortunes. The analysts predict that earning will surge 10.2% in the last three months of 2019 over the same span last year, setting an all-time record, and salvaging the year.

Sounds like Q4 will be a blockbuster quarter. It sure better be for full-year profits to wax 5.5%, given the drag from the first nine months. The CBO reckons that growth in 2019 will start moderately strong, then slide as the year wears on, culminating in a weak Q4. The agency projects a “nominal” reading of 4.3% (or 2.3% real) for all of 2019, with expansion averaging 4.5% for the first nine months, then dropping to 3.8% in Q4. That means Q4 growth would fall to a meagre 1.8% excluding inflation.

So will earnings sprint just when the economy goes into a slog? In its recent report “The Budget and Economic Outlook: 2019 to 2029,” the CBO projects that the year-over-year, 9.2% surge in business investment that powered the 3.1% expansion won’t come close to repeating. This year, the agency expects capital spending to rise a meagre 2.0%. The CBO contends that the lift from the corporate tax cuts and immediate write-off of capital investment provided a one-time boost that will fade during 2019.

Revenues can’t grow fast enough to generate 10%-plus earnings growth while the economy falls into a near-funk. GDP growth and sales are joined at the hip, so unless already lofty margins soar to unheard-of heights, that double-digit target is an illusion. In fact, a weakening economy means that sales, and profits, should barely beat inflation at best. The Wall Street outlook and the CBO scenario at at loggerheads. Believe the CBO.