Corporate profits are the mother's milk for equity prices, and they are stronger than ever relative to the size of the economy. No wonder the stock market has done so well in recent decades.
Chart #1
Chart #1 compares corporate profits (adjusted, and ex-Fed profits) to nominal GDP. According to the Q4/25 GDP estimates released today, corporate profits at the end of last year were up 8.4% from a year ago, and they totaled $3.6 trillion at an annualized pace.
Chart #2
Chart #2 shows the ratio of corporate profits to nominal GDP. As of the end of last year, profits were a record-setting 11.5% of GDP. Wow. Just Wow. And it's not just a recent phenomenon. As the chart also shows, relative to the size of the economy, profits in recent years have been running twice as strong as they were in the 80s and early 90s.
Chart #3
Chart #3 shows the long-term path of the S&P 500 index, as compared to an 8% annualized trend. When you add dividend yields of 1-2% per year, buying and holding stock in the country's 500 largest and most successful corporations has yielded about 10% per year since 1950.
Of course, there are times when returns have been far less than 10% per year, and far greater. If you bought stocks in October 2000, you wouldn't have broken even for almost 7 years. In contrast, buying stocks in April 2009 (at the bottom of the Great Financial Crisis) would have delivered annualized returns of almost 15% plus dividends. I was several months early when in November 2008 I argued that investing in stocks was the buying opportunity of a lifetime.
In any event, these three charts suggest that stocks today are neither very cheap nor very expensive from an historical perspective.
Is the implication that the "K-shaped economy" will not only continue but become even more pronounced?
ReplyDeleteOmg Scott , ur link to your old post. Soooo good!!!
ReplyDeleteCurious, what do you make of the fact that corporate profits are taking up a bigger and bigger chunk of the GDP versus the historical average? Could there be a aversion to the mean on this one or is it just because productivity is increasing overtime and thus corporate profits are capturing a larger part as a percent of GDP
*reversion*
DeleteI believe Scott has mentioned in the past, corporate profits amounting to a larger percentage of GDP, is a byproduct of the US capturing additional corporate profits due to increased globalization. We capture global profits in addition to domestic profits, and this looks durable due to structural changes globalization, benefitting US corporate profits.
ReplyDeleteAtaraxia is correct. It's all about globalization.
ReplyDeleteCorporate Profits, Recent experience:
ReplyDelete"Technology" (meaning digital micro-electronics and related sectors) is one of the biggest reason for the increases in profit margins. Globalization of these business sectors also contributes. The Mag7, even though about 3-4 have hardware/tangible asset requirements in their business models, (Tesla, Amazon, Apple, Nvidia), own very little tangible capital. That keeps capital costs low, and margins high. (e.g. Apple and NVIDIA own very little to none of the factories required to make their hardware.)
They exploit the lower labor and environmental costs globally as part of their effort to lower costs. The US and other developed economies loaded costs onto employers (costs of hiring workers in home countries), and then moved the tangible (dirty) work to global suppliers.
I worked in a "global" tangible supplier (emerging economy country) for 4 years, so I saw the reality first hand. In the '90's I was very much for the globalization opportunity. By about 2005 the evidence was showing that the reality did not meet expectations for the middle income and lower households in the developed countries.
Q1 profits coming in strong too. The world's best-run large organizations must be listed on Wall Street. At times our own government seems like it is against enterprise...and still profits go up.
ReplyDeleteAm I thinking about this correctly? Does the yield curve look healthier than it was over the last decade? Meaning higher real Yields throughout the total duration, providing both more room for the FED to lower and an actually real return balance on the bond portion of a total stock/bond portfolio? Thoughts anyone?
ReplyDelete