Here is a fitting update for the end of the first quarter.
One insight generated by the use of global leading economic indicators is that, if corporate earnings are a long leading indicator and stock prices a short indicator, then it stands to reason that corporate earnings actually lead, rather than track, actions, at least when measured. quarterly average. If it wasn’t clear before, then this graphic by Scott Grannis, aka Calafia Beach Pundit, dispels any doubts:
Although I’m not in the business of investment advice, even a cursory glance suggests that there’s generally still plenty of upside potential in most bull markets, even after corporate earnings have fallen. reached a peak!
But to the point. Since the first quarter of 2016 is over, let’s update this relationship, showing stock prices (blue) versus corporate earnings (red), both normalized at 100 since the last stock market peak in the fourth quarter of 2007.
As expected, corporate profits initially took off after the Great Recession, and stock prices have caught up. Corporate profits dipped in 2012-2013, then improved very gradually until declining in the last two quarters. Once stock prices caught up in 2014, they followed the corporate trend closely.
Here is the same information as the YoY% changes:
Again, the lead/lag relationship is clear, although there can be YoY divergences for long periods.
This tells us that equities remain as highly valued as a share of corporate earnings on a relative basis as they were in the fourth quarter of 2007, their previous peak. But what about the profits of the companies themselves? A comparison of corporate profits as a percentage of GDP is very instructive:
As a percentage of GDP, corporate profits over the past 10 years, outside of the last recession, hit or near a 70-year high as a percentage of GDP, before falling sharply at the end of last year.
Here is a close-up of the last 6 years:
By the way, in a democracy, this kind of imbalance is going to backfire – and it did, in the form of Donald Trump on one side and Bernie Sanders on the other.
Leaving aside this important equitable consideration, the above shows that:
1. Stocks are highly valued relative to corporate earnings, and
2. Corporate profits themselves, which were at extreme levels as a percentage of GDP, are still relatively high compared to the long term.
Under these circumstances, while there is always room for manoeuvre, it does not seem likely that stock prices will outperform corporate earnings in the near future, and corporate earnings themselves have more room to fall than to increase.
Warning: I am a business blogger. This message contains opinions and observations. It is in no way professional advice and should not be interpreted that way. In other words, buyer beware.