Thursday, March 29, 2012

Corporate profits continue to impress



Today's release of fourth quarter GDP revisions showed little change, but it did provide us with the first look at corporate profits for the quarter. After-tax corporate profits rose 8.5% last year to $1.58 trillion on a seasonally adjusted annual basis. As the charts above show, this was a record both in nominal terms and relative to GDP; in fact, corporate profits have been breaking both these records since the fourth quarter of 2009.


Ordinarily, you would think that 9 consecutive quarters of record-setting corporate profits would be cause for great celebration on Wall Street, with jubilant investors sending PE ratios to the moon, but you would be dead wrong. Instead, the PE ratio of the S&P 500 today stands at 14.4, well below its 50-year average of 16.6, and down sharply from its Q4/09 average of 21. What does this mean? It's simple: investors don't believe corporate profits can continue to rise, having already wildly exceeded previous highs relative to GDP. Indeed, I would argue that the stock market is priced to the expectation that corporate profits are likely to decline significantly, both in nominal terms and relative to GDP. Call it a mean-reversion expectation: profits, according to the market's logic, should sooner or later return to their long-term average of just over 6% of GDP, and perhaps fall even further—there's no way they can remain this high.

I think this is a pretty pessimistic outlook, but no matter what adjective you use to describe the market's expectations, it would not be anything like optimistic.


This chart of U.S. corporate profits (the same profits used in the other charts above) relative to global GDP puts the issue in a whole new light. Suddenly, profits are not usually high at all. Why the huge difference? U.S. corporations have been busy globalizing in recent decades, and the global economy has been growing much faster than the U.S. economy. U.S. corporations now address a global market that has grown by leaps and bounds, and profits as a share of global GDP are about average. It no longer makes sense to look at corporate profits as a share of U.S. GDP. Anyone who today can sell his products and services to the world has the ability to make profits that were inconceivable just a few decades ago. For starters, think Apple, Hollywood, and Qualcomm: Apple is now a major player in the gigantic Chinese mobile phone market; Hollywood films are watched by billions of eyeballs; and Qualcomm chips are in the vast majority of smartphones, the fastest growing segment of the global mobile phone market. In short, the rationale for expecting a significant deterioration in corporate profits that seems to have infected the equity market is not compelling at all.

And that means that you don't have to be a wild-eyed optimist to like today's equity valuations. Even if you don't think that U.S. growth is going to pick up in any meaningful fashion for a long time, profits could continue to impress.

16 comments:

Benjamin said...

I really liked this post. Corporate profits---the private sector---continues to do more with less, every year.

It is the public sector---social welfare, military---that accomplish less with more every year.

I have to say, the people who say Obama would crush the American spirit have to explain why corporate profits are doing far better now than under Bush.

Keep as much of your economy in the private sector as possible. And then give it an adequate money supply.

marcusbalbus said...

extraordinary high corp profits mean supressed income for labor. not good.

Unknown said...

Interesting market action today. At 3pm Eastern time, Edmunds reported its estimate for March auto sales at 14.9 SAAR. It was right afterward that the Dow and the market in general spiked higher, seemingly led by AA and CAT. I can't find anything else which would have suddenly propelled the market higher. Ford and GM suddenly started going higher too. Do the markets really pay attention to relatively obscure stuff like Edmunds' auto sales projections?

Just thinking out loud.

Dr William J McKibbin said...

I understand that government employees and others with qualifed retirement plans (IRA's, 401k's, SEP's, etc) may soon be required to maintain at least a third of their portfolios in domestic bonds -- what a deal...

Benjamin said...

worth reading

http://www.dallasfed.org/assets/documents/research/staff/staff1202.pdf

PD Dennison said...

Scott,

This is a great point. The international character of large US corporations does not appear to be fully appreciated in the market.

Your International GDP chart is a more accurate read on these companies.

PD Dennison said...

The Obama Administration has not crushed the American spirit, despite the attempts.

Unfortunately, it is the "little guy" that has suffered from the poor employment opportunities and poor investment returns (house and stock prices).

Dr William J McKibbin said...

@PD Dennison, if you dislike Obama, wait until the Republicans take over -- let's face it, Republicans can't wait to put everyone earning less than a million dollars annually into their place once and for all -- neither the Republicans nor the Democrats have any pragmatic solutions for the future...

http://www.lp.org/

Make Money Online said...

Great tips for the money making, i really appreciate the efforts by you. Commodity Tips, Intraday Tips

PD Dennison said...

Many of Scott's articles focus on the role of government and how it can crowd out the private sector, where growth and wealth are created.

The Democrat Party is the party of larger government. The Republican Party is the party of smaller government (though not all Republicans are on board).

The Libertarian Party can only empower the Democrats.

Apparently, you like the Obama Administration.

sturdeebeggar said...

Blow off all this political crap. Christ, grow up.

Jim said...

corporate profits driven by budget deficits. What is with all the enthusiasm?

vishal said...
This comment has been removed by a blog administrator.
Paul said...

thanks for this post. I especially think #1 is a great tip., This post makes a great point about focusing your efforts.

stock tips,equity tips | Currency Trading Tips,Forex Tips,Forex Pairs

jimi said...

Our beautiful Naples provided apartments and homes are among the mortal joint structure in the Metropolis country. With our lovesome and reasoned body, you will be provided relocation options to fit your requirements and be competent to superior your perfect short-term or long-term accommodations.
naples corporate housing

ali kara said...
This comment has been removed by a blog administrator.