Corporate Profits, the mother's milk of stocks and the economy have weakened dramatically over the past 6 quarters. Energy firms, Apple, and the ending of many corporate tax credits have all caused a deterioration of overall corporate profitability. Without profits firms are unable to increase investment and expand hiring and if credit conditions deteriorate as well then corporations start to shed employees and cut back dramatically on investment. Over the past 10 quarters, overall after tax domestic profits have dropped by over 20%. As a percentage of nominal GDP the drop is more dramatic with a drop of almost 27% - dropping from 7.57% in Q2 2013 to 5.53% at the end of 2015.
S&P 500 Earnings per Share (EPS) tend to lag the overall profitability of the economy by 3-4 quarters. The relationship is pretty good over time - making a large profit rebound in 2016 in S&P 500 EPS unlikely. In the chart below, S&P 500 EPS are in red and clearly following the drop in overall domestic profits.
The situation is not yet dire, but one might characterize the profit situation as a "Yellow" caution light for this economic expansion. Further deterioration coupled with tighter credit conditions would be a harbinger of an overall economic recession.
Kevin Spires, CFA, FRM
Kevin Spires, CFA, FRM
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