In my view, one of the most enduring and extraordinary features of the current business cycle expansion has been the strength of corporate profits. According to the GDP stats released yesterday, third quarter after-tax corporate profits hit a new nominal high of $1.87 trillion, and a new high relative to GDP of 10.3%. So it's no wonder that equities are hitting new highs. Indeed, despite profits hitting all-time record highs, PE ratios today are only slightly above average. Stocks by this measure still look quite attractive.
From 1958 through 2004, after-tax corporate profits averaged about 5.3% of GDP. Since then, and including the profits collapse of the Great Recession, after-tax corporate profits have averaged 8.8% of GDP. As the chart above shows, over the entire period since 1958, corporate profits have averaged about 6% of GDP. For the past 5 years, equity bears have in effect argued that profits were unsustainably high because they had a strong tendency to be mean-reverting to, say, 6% of GDP. Instead, profits have just continued to grow, both nominally and relative to GDP. A pessimistic outlook for corporate profits has essentially been the driving force behind the equity market's gains, because profits have far exceeded expectations. In a sense, the market has been forced higher because profits have been much stronger than expected....MUCH MORE