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By New_Deal_democrat January 5, 2016 9:32 am
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Corporate profits vs. stock prices and GDP
One insight generated by making use of overall leading economic indicators is that, if corporate profits are a long leading indicator, and stock prices a short one, then it stands to reason that corporate profits actually lead, rather than follow, stocks, at least when measured as a quarterly average.
Since Q4 2015 is ended, let's update this relationship, showing stock prices (blue) as compared with corporate profits (red), with both normed to 100 as of the last stock market peak in Q4 2007:
As expected, corporate profits took off first after the Great Recession, and stock prices caught up.  Corporate profits moved sideways in 2012-13, and since have improved in a very gradual manner.  Once stock prices caught up in 2014, they have closely tracked the corporate trend.
Here is the same information as YoY% changes:
Again, the leading/lagging relationship is clear, although there can be YoY divergencies for extended periods.
This tells us that stocks are as richly valued as a share of corporate profits as they were in Q4 2007, their previous peak.  But what of corporate profits themselves?  A comparison of corporate profits as a share of GDP is very instructive:
Corporate profits in the last 10 years, outside of the recession itself, have been at or near a 70 year record as a share of GDP!
Here is a close-up of the last 5 years:
In a democracy, this kind of imbalance is going to create blowback -- and it has.
Leaving aside this important equitable consideration, the above shows that:
1. stocks are richly valued compared with corporate profits, and 
2. corporate profits themselves appear to be at extreme levels as a share of GDP.

Under those circumstances, although there is always wiggle room, it does not seem likely that stock prices will outperform corporate profits in the near future, and corporate profits themselves are more likely to stall or fall than to rise.

Disclaimer:  I am an economic blogger. This post contains opinions and observations. It is not professional advice in any way, shape or form and should not be construed that way. In other words, buyer beware.

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