Corporate Profits As Leading Stock Prices: Year-End 2016 Edition

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By New Deal Democrat

One insight generated by making use of overall leading economic indicators is that if corporate profits are a long leading indicator, and stock prices a short one, then it stands to reason that corporate profits actually lead, rather than follow stocks, at least when measured as a quarterly average.

Since Q4 2016 has ended, let's update this relationship, showing stock prices (blue) as compared with corporate profits (red), with both normed to 100 as of the last stock market peak in Q4 2007:

As expected, corporate profits took off first after the Great Recession, and stock prices caught up.

Before I go further, though, let me post the exact same graph as it existed one year ago:

One year ago, the graph showed that corporate profits moved sideways in 2012-13, and since have improved in a very gradual manner. Once stock prices caught up in 2014, they have closely tracked the corporate trend.

But the BEA has since significantly revised its corporate profit series (interestingly, to be more in line with that reported by Barron's each week, suggested that private data rather than the BEA may be the more accurate way to look at this metric). While the comparison still shows that corporate profits lead stock prices in terms of peaks and troughs, even in the last two years, it now suggests that the S&P 500 has been more richly valued in the last several years than even at the 2007 peak.

The BEA revisions to corporate profits data also changes the comparison of corporate profits as a share of GDP:

Last year, I noted that "corporate profits in the last 10 years, outside of the recession itself, ha[d] been at or near a 70 year record as a share of GDP," and further, that "in a democracy, this kind of imbalance is going to create blowback."

The candidacy of Bernie Sanders, and the election of Donald Trump, certainly demonstrated that blowback - although early indications are that the imbalance is, if anything, likely to be further exacerbated. Certainly, the rotation out of bonds into stocks since the election suggests that, at the very least, repatriation of foreign profits is likely and will be good for companies' 2017 bottom lines. At the same time, an increase of only 10% in corporate profits from the Q3 level will put them right back at a 70-year extreme as a share of GDP.

New Deal Democrat, XE.com

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