Thursday, May 27, 2010
Along with today's latest revision to Q1/10 GDP, we also received the initial estimate of corporate profits. In the year ending March '10, adjusted corporate profits after tax rose 24% from a year earlier. Compared to profits in 1998, when the S&P 500 was trading at approximately the same level as it is today, profits today are about twice as high. Looked at another way (second chart), profits as a % of GDP were about 6.5% of GDP in 1998, whereas today they are 7.7%, a level that rarely has been exceeded in the past 50+ years. Of course, many would argue that the market was entering bubble territory in 1998, but if even if that were indeed the case (though it was not obvious back then, as I recall), then surely equities are not overvalued today.
As the last chart shows, the recent strength in profits is by and large coming from nonfinancial domestic corporations, the meat-and-potatos sector of the economy, if you will.
I look at these facts and come away thinking that the corporate profits picture looks pretty darn impressive, especially considering how much the economy has been struggling in the past year or two. Equities are just not getting the respect that these numbers suggest they deserve. (Note that I am using the National Income and Products Accounts measure of profits, not the profits that are commonly used to calculate PE ratios. In my experience NIPA profits are much less volatile and more reliable, since they include all corporations and they are adjusted for inventory valuation and capital consumption allowances, so they are effectively equivalent to true economic profits. I owe a big HT to Art Laffer for this, since he has been following this series closely for as long as I can remember.)
Posted by Scott Grannis at 7:21 PM