There is a great divergence between corporate profits and economic indicators with the indicators currently in the driver seat of stock prices.
These economic indicators have been heading lower as many have underestimated the negative impact of the disaster in Japan.
So, some are arguing that the corporate earnings will eventually catch up to these lower indicators citing that the corporate profits as percent of GDP are at an all time high.
History suggests today’s corporate earnings are unsustainably high relative to the size of the economy. The real price-to-earnings ratio, based on a more normal level of earnings, is well over 20.
The SmartMoney writer, Jack Hough, notes that corporate profits were this size only twice in the US history – 1929 and 2006 – all years that ushered in nasty economic depressions.
However, as the chart on the left shows, change in corporate profits does correlate with the changes in the GDP, so any GDP shrinkage has dire consequence for corporate profits and if they are at the all time high like now the path of lowest resistance is down.
Then there are those who dispute any relationship of GDP to stock prices.
From Vitrus Mutual Funds:
Common wisdom is that countries with strong long-term economic growth prospects are more likely to provide attractive stock market returns than countries with slower growth expectations. Interestingly enough, the historical data does not back up this belief.
Vitrus cites Dimson, Marsh, and Staunton’s Triumph of the Optimists: 101 Years of Global Investment Returns and Professor Jay Ritter’s paper Economic Growth and Equity Returns who show that there is not much relationship between real GDP and real equity returns.
Hm? Real huh. Swell even though stocks move on the reported nominal EPS with “real” one best left to academicians.
Anyway, with lack of positive market catalysts as of late some are pinning hopes on corporate earnings as the bright star that can move the market higher.
There are 14 notable earnings releases this week whose earnings, guidance and prospects could help swing the market.
These names report on various dates this week. The number next to symbol is the expected EPS.
Business activity & manufacturing: