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By New_Deal_democrat August 28, 2015 8:49 am
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Corporate profits lead stock price: important update re Q2 corporate profits

Lost in the frenzy this week has been that second quarter corporate profits were reported by the BEA.  To reiterate, since corporate profits are a long leading indicator for the economy, and stock prices a short leading indicator, it makes sense that the direction of corporate profits leads the direction of stock prices, when averaged over a quarter.

 
So here is an update of my graph showing corporate profits (blue) vs. stock prices (red):
 
 
Due to this week's thrilling action at the dog track, I am using daily S&P 500 prices for this comparison.  Here is a close-up of the last year:
 
 
Note that the graph norms both stock prices and corporate profits to Q4 2007, when stocks were at their richest valuation prior to the Great Recession. This year, stock valuations caught up with corporate profits -- until a couple of weeks ago. In this context the recent correction amounts to a "reset" of valuation at more reasonable levels, while the good news on Q2 profits, which set a new record, argues that sometime in the near future, equity valuations will follow.
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