Bull Markets Are Invincible: Get This Party Started

by: ColoradoWealthManagementFund


The bull market continues moving higher even as earnings fade.

Earnings and wages have been inherently at odds because wages reduce profits.

Simple charts demonstrate the strong negative relationship.

Weak wages and high profits result in further concentration of capital.

The top 10% has not enjoyed this kind of superiority since the 1930s.

The market moves ever higher as investors and analysts clamor to get shares. The scene reminds me of people fighting to get the last "Tickle Me Elmo," but there are no Black Friday sales here. Rather than investors rushing for a sale, they race to buy indexes and mutual funds with little regard for the contents. Does it really matter to some of them? The market is going higher! We survived Brexit! Panic over a country leaving the EU is over. The market marches ever higher.

Such a rally could never end, because the fundamentals support higher share prices. The weak yield on governments bonds easily justifies the cost of indexes, since surely earnings will only climb higher. Perhaps GDP (Gross Domestic Product) is only growing at mediocre rates, but what should stop corporate earnings after taxes from taking a larger share of GDP? Surely, the latest dip will correct and new records can be set.

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Imagine an investor looking only at the last 15 years. He would believe anything under 6% was an absurd abnormality and that values over 7% were common. However, if he could only see from 1980 to 2000, he might believe that values over 7% were a joke and that increases in profits could only be temporary illusions. If he saw the fallout of the tech burst at the start of the century, he would surely think it was the result of irrational exuberance. After nearly 15 years, our viewpoint has changed substantially. High profits are normal, and there can be no harm in higher profits. Who would want to see fewer profits? Who would wish for higher costs? How could an economy grow with higher costs?

There is a fundamental problem with assuming that higher costs are inherently bad for growth. The issue is that all costs are simply lumped together. Corporations are not simply centers of profit. It is surprisingly easy to evaluate the different costs a corporation will have. They will have to pay wages, buy raw materials or other goods, pay interest on debts, and pay taxes. Eventually, they will need to invest capital in creating new productive capacity. However, that last one has not been a major use of capital over the last several years. Depreciation, over the course of several years, will reflect the cost of investing to produce new capacity.


One of the major sources of higher corporate profits after tax is the reduction in wages. Since wages are a tax-deductible expense, decreasing wages by 1% of GDP should increase corporate profits after tax by less than 1% of GDP.

Gross Domestic Income

In this piece, I will be referring to GDP. Some figures use GDI (Gross Domestic Income). In theory, the two values are the same. The calculations to reach them are different, but the two values should be equal. In practice, they may be slightly off. The difference should be immaterial.

For instance, for the first quarter of 2016, GDP was $18,230 billion. GDI was $18,524 billion.

Growth in Profits Come at the Expense of Workers

This is not a political statement. It is an economic statement. Over the last several decades, the connection between corporate profits and wages has been extremely clear. While wages were higher, the two remain connected. Corporate profits were running between 3% and 11% of GDP. Wages ran between 55% and 40% of GDI. To put the values on the same scale, it was necessary to make an adjustment. I adjusted all the wages values by subtracting .4. Therefore, 50% will show up as 10% and 45% will show up as 5%.

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There you have it. Nearly 70 years of economic data boiled down to one quick chart. The negative correlation here should be obvious. It should be no surprise that a reduction in wage expense creates a corresponding increase in profits. The increase is slightly smaller due to taxes, but it is there. The following chart adds in a line for the average:

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The average of the two lines started at slightly less than 9%. That means the two values would have been about 18% and that the combined share of GDP (or GDI) would have been roughly 68%. Remember that the percentage for wages includes a reduction of 40%.

Growth in Earnings is Not Growth in the Economy

The rapid growth in corporate earnings has not been the result of rapid expansion. It came through corporate earnings after taxes increasing dramatically as a percentage of GDP. While the current earnings yield on the domestic equity indexes is tolerable in a world filled with negative interest rates, the high valuation across equities requires corporate earnings to remain strong. Continued strength in earnings, absent other factors like tax reductions, requires wages to remain low as a percentage of GDP. The consequence of low wages is a further concentration of capital.

More Data Is Better

I would prefer to have this data going back to the late 1800s, but it simply does not exist. There was no entity recording this data at that time, so it is not possible to go back that far. However, there are some alternatives. A few data series go back beyond the Great Depression.

One great one shows the percentage of total wealth owned by the top .1%, the top 1%, and the top 10%. See the chart below:

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As you can see, the highest values for all three of these categories were observed around 1910, and they declined only slightly leading up to the 1920s. We do not see a higher level than today unless we back to the 1930s. The 30s were a great time for all Americans, because of the enormous gains of the 1920s, the Roaring Twenties, into the party that never stopped.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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