Are profits the problem?

The Doctor explains why profits may not mean good for shares. This was also paraphrased by an article from Warren Buffet showing how GDP growth did not correlate well with stock prices.

Adapted from the Daily Reckoning
By Dr. Richabachur

“The customary way of making forecasts of economic developments is to extrapolate the recent past. Profit growth in the United States during the last two years has been at its best for the whole postwar period. Profits of the non-financial sector in 2005 have jumped to $900.1 billion, from $584 billion in 2004 and $411.8 billion in 2003. These figures compare with a profit peak of $508.4 billion for the sector in 1997 and a profit low of $322.0 billion in 2001.

If you look at the profit development of U.S. corporations over the last 10 years, you will see that it is an awkward picture. Profits fared very poorly during the “New Paradigm” years of the late 1990s, presumably a time of excellent economic performance. No less astounding is their sudden steep rise in the course of 2005, from $624.2 billion in the fourth quarter of 2004 to $1,027.7 billion in the first quarter of 2006,happening while the economy distinctly slowed.

The irony is that after a strong rise during the first half of the 1990s, profits abruptly turned down during the “New Paradigm” years of the late 1990s. For six years, from the recession year 1991-97, the non-financial sector’s profits had soared from $227.3 billion to $508.4 billion. As a percentage of GDP, these profits had risen from 3.8% to 4.9%.

While “New Paradigm” ballyhoo and stock prices flourished after 1997, business profits, as officially measured, suddenly slumped. As a percentage of GDP, they were a little higher at the height of the dot-com bubble than in the recession year 1991.

Coming to the recent recovery years, we must point to some irritating observations. On the surface, it looks like a fabulous profit development. From recession year 2001 to 2005, profits of businesses in the non-financial sector have more than tripled, from $322 billion to almost $1,100 billion. It was the best profit performance of all time.

However, this good-looking total consisted of two extremely different parts. It was in the first quarter of 2004 that profits exceeded their peak of 1997 for the first time. From there, they shot up almost vertically. Typically, it has been inverse that the very first years of recovery were best for profits. “


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