The growth trend of corporate profits is determined by the growth trend of nominal GDP. My analysis shows that the trend of these variables has been 7% since 1960. Profits growth is much weaker during recessions and much faster during recoveries, but 7% has been the magic number for the trend. That seems to be the best we can expect in the coming years until the next recession. Given that valuation multiples are at their historical highs, 7% may also be the best we can expect in terms of annual capital gains in the stock market for the duration of the current bull market. That’s quite good compared to the bond yield and the inflation rate, which are both historically low.
On a cyclical basis, there is a strong correlation between the y/y growth rates of nominal GDP and S&P 500 revenues in aggregate. The correlation is even better with nominal GDP for goods. The two series do diverge often on a short-term basis, but have the same cyclical pattern. During Q1, revenues fell 2.5% y/y, while nominal GDP with and without services rose 3.6%. The recent plunge in oil prices had a bigger impact on S&P 500 revenues than on nominal GDP.
Over the past four and a half years, nominal GDP has been growing just under 5%, so it’s possible that this may be the new magic number for the trend growth in GDP, and therefore in profits. While there has been some recent chatter about the depressing impact of seasonal adjustment factors on Q1 real GDP, that distortion is eliminated simply by tracking the y/y growth rate, which has been relatively stable around 2.5% since mid-2010. In fact, while real GDP fell 0.7% (saar) during Q1, it was up 2.7% y/y! Meanwhile, inflation continues to decelerate in the GDP accounts. The GDP price deflator was up just 0.9% y/y during Q1, with the core rate also low at 1.1%. Again, put these trends together, and nominal GDP is growing below 5% rather than close to 7%.
Today's Morning Briefing: Probing Profits. (1) Profits measures: Take your pick. (2) We pick forward earnings. (3) Is the 7% trend still our friend for profits growth, or might it be 5%? (4) How much longer can profit margins break records? (5) Cash flow stalled at record high. (6) The government should fill potholes. (7) Assessing the soft patch in the oil patch. (8) Regional surveys add up to weak May. (9) Frightful freight index. (10) Signs of life in Eurozone’s corporate earnings. (More for subscribers.)
On a cyclical basis, there is a strong correlation between the y/y growth rates of nominal GDP and S&P 500 revenues in aggregate. The correlation is even better with nominal GDP for goods. The two series do diverge often on a short-term basis, but have the same cyclical pattern. During Q1, revenues fell 2.5% y/y, while nominal GDP with and without services rose 3.6%. The recent plunge in oil prices had a bigger impact on S&P 500 revenues than on nominal GDP.
Over the past four and a half years, nominal GDP has been growing just under 5%, so it’s possible that this may be the new magic number for the trend growth in GDP, and therefore in profits. While there has been some recent chatter about the depressing impact of seasonal adjustment factors on Q1 real GDP, that distortion is eliminated simply by tracking the y/y growth rate, which has been relatively stable around 2.5% since mid-2010. In fact, while real GDP fell 0.7% (saar) during Q1, it was up 2.7% y/y! Meanwhile, inflation continues to decelerate in the GDP accounts. The GDP price deflator was up just 0.9% y/y during Q1, with the core rate also low at 1.1%. Again, put these trends together, and nominal GDP is growing below 5% rather than close to 7%.
Today's Morning Briefing: Probing Profits. (1) Profits measures: Take your pick. (2) We pick forward earnings. (3) Is the 7% trend still our friend for profits growth, or might it be 5%? (4) How much longer can profit margins break records? (5) Cash flow stalled at record high. (6) The government should fill potholes. (7) Assessing the soft patch in the oil patch. (8) Regional surveys add up to weak May. (9) Frightful freight index. (10) Signs of life in Eurozone’s corporate earnings. (More for subscribers.)
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