Corporate profits

What is the relationship between corporate profits and GDP?

Do Do investors really understand the economy or the business cycle? The recent surge in stock indexes challenges the assumption that markets believe there is a relationship.

As I have said many times in the past, it is not necessary to have short-term correlations between the economy and the markets. There are millions of reasons why the markets go one way and the economy the other. A review of corporate profits indexed since 1990 shows that corporate profits have grown at nearly double the rate of improvement in GDP. Obviously, the profits had grown much faster than the economy.

Corporate profits (red line) vs GDP (blue line) indexed to 1990

But since the Great Recession (aka New Normal), there’s a much closer correlation between corporate profits and economic growth.

Corporate profits (red line) vs GDP (blue line) indexed to 2007

The new normal would suggest that the market is paying more attention to GDP as a guide to market valuation. With the market looking to the future, it is necessary to know the economic situation in months. It looks like most forecasters are forecasting economic growth of around 2.8% over the next 12 months – and that also suggests that the market rise over the next 12 months should also be in that range.

Last week we released our economic forecast which remains at one of the lowest levels since the end of the Great Recession. Our economic forecast is designed as a Main Street measure – not a GDP forecast. However, there are correlations as can be seen in the graph below.

Annual GDP growth (red line) compared to the Econintersect economic index (blue line)

Econintersection believes that looking at year-over-year growth is a better way to look at GDP – and our economic forecast is based on year-over-year growth. In addition, our forecasts are issued four months before the publication of the GDP.

From all the evidence we see, economic growth will be moderate at best over the next six months. The market valuation (based on historical New Normal correlations) should follow this moderate growth.

Other economic news this week:

the Econintersection The economic index for November 2015 improved slightly – but remains in the low range of index values ​​seen since the end of the Great Recession. The most watched sectors of the economy have generally shown some growth. Our economic index has nonetheless been in long-term decline since late 2014. Our six-month employment outlook continues to forecast weakening employment growth.

The ECRI WLI growth index is now in positive territory but still indicates that the economy will experience weak growth in 6 months.

Current ECRI WLI growth index

The market (from Bloomberg) expected the first weekly jobless claims to be between 245K and 270K (consensus 265,000) from the reported 259,000. The largest 4-week moving average (due to volatility in claims reported weekly and seasonality errors when adjusting the data) fell from 265,250 (reported last week as 265,000) to 263,250. Moving averages have generally been at or below 300,000 since August 2014.

Initial weekly jobless claims – 4 week average – Seasonally adjusted – 2011 (red line), 2012 (green line), 2013 (blue line), 2014 (orange line), 2015 (purple line)

Bankruptcies this week: RAAM Global Energy

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.