Profits and GDP help explain the stock market rally of the post-Covid period.
Corporate earnings come from these profits. The computation of profits in the National Income and Product Accounts (NIPA) are derived from a consistent series. These are “economic profits” versus earnings reported using GAAP accounting (“generally accepted accounting principles”).
That said, the earnings we see must start with the profits in the GDP accounting.
So, Chart 1 below depicts the changes in the period 1970 to date, and we have annotated as much as possible for readers to see the details. Hat tip to Tom Paterson of Cumberland for working with me on these annotations.
The evidence is apparent. Grow GDP and grow the rates of change (delta), and earnings improve, and stock prices rise. Accelerate delta (gamma) and the result is more robust. Continue that trend and don’t disrupt it with crazy politics, and the beneficial outcome it is likely to continue. Markets like stability and positive trends. Investors get rewarded when governance is stable and predictable and not chaotic and threatening.
Now let’s look at chart 2.
Here is the trend in nominal terms. In other words, nominal GDP (which includes inflation) and rising profits and rising stock prices all go together for the obvious reason. We live and work and earn and transact in a nominal world. This is why the stock market has an upward bias. As long as inflation stays low (around 2%) and the trend is slowly rising, the business and investing community can adjust and the growth in profits and earnings SHOULD capture the inflation and the real growth from business improvement and productivity gains. Bonds then adjust for inflation expectations. And financing is more stable when it comes to the nominal interest rate. IMO, the biggest threat to this outlook is chaotic politics and the second biggest threat is war. In some ways these two big threats are related, as history proves again and again.
You can see the recessions and volatility in both charts. The negative periods are coincident with shocks like Covid and shocks like chaotic politics, debt-ceiling fights, and failures of governance like no federal budget, as we are currently seeing in the House of Representatives. At least Speaker Johnson (to his credit, IMO) has publicly committed himself to avoid distortions from the debt ceiling fiasco which have been caused by the “Crazy Eight” House members and the others that join them. Note that the voters continue to reject some of the Crazy Eight, and that now includes a ringleader, Rep Good, who has lost his primary. A recount has now certified the loss (“Recount confirms Bob Good’s loss after GOP rallies to oust one of their own,” https://www.politico.com/news/2024/08/01/recount-confirms-bob-goods-loss-after-gop-rallies-to-oust-one-of-their-own-00172424).
Financial market agents want stability and policy, not crazy politics and chaos. Financial markets want predictability of trends and forecastable earnings derived from economic profits.
The charts tell the story.
For Cumberland’s portfolio details, contact Matt McAleer, John Mousseau, or Ben Pease.
