What's Wrong With Stock Prices?

Today's revision to second quarter GDP brought with it our first look at corporate profits, and they were once again very strong, if not fairly spectacular. Not only were after-tax profits up over 9% relative to a year ago, corporate profits are now at an all-time record high of 10.1% relative to GDP. We've never seen anything like this.

So the question that absolutely begs to be answered is this: Why haven't equity prices kept pace with the huge increase in corporate profits? After-tax corporate profits averaged $554 billion in 2000, and the S&P 500 index averaged 1423 that year. Now corporate profits have soared by 173%, but equity prices have fallen by over 17%. Hold on, you say, it's obvious that equity prices were in a bubble in 2000. Ok, so let's go back to 1995 for purposes of comparison. In 1995 the PE ratio of the S&P 500 was 16.5, about equal to its long-term average, and the index averaged about 550 that year while after-tax corporate profits averaged about $500 billion. So in the past 16 years, corporate profits have tripled, while the S&P 500 has only slightly more than doubled. There's no getting around the fact that equity prices have seriously lagged the performance of corporate profits.