The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

30 March 2006

Corporate profits still very strong

The following comments are from Scott Grannis, Chief Economist at Western Asset Management...
-- David M Gordon / The Deipnosophist

Along with the final revision to fourth quarter GDP (growth revised upwards slightly to 1.7%, inflation revised upwards to 3.5%), BEA today released their calculation of corporations' after-tax economic profits, and it was a barn-burner of a number. Profits rose 9.4% in 2005, compared to 2004, and fourth quarter profits soared to 8.3% of nominal GDP, the highest ratio on record. Profits have more than doubled from their 2001 low. Corporations' net cash flow was $1.4 trillion at an annualized rate in the fourth quarter (fully one-eighth of GDP!), up 18.5% from a year ago. Simply put, there's a heck of a lot of positive stuff goin' on out there.

[click on image to enlarge]

Since NIPA profits typically lead GAAP profits, we can infer that reported earnings will remain very strong for at least the next 6-9 months. This further suggests that equities remain attractive. Using Laffer's capitalized profits model, equities continue to be a steal.

Bonds, meanwhile, do not look very attractive. The second chart subtracts a 3-year moving average of inflation, as measured by the GDP deflator, from current bond yields (arguably a better measure of inflation and inflation expectations than current core rates). Real yields by this measure haven't been so low since 1979-80.

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