Profits and GDP

Another interesting barometer of the market is what percentage corporate profits make up of total GDP. In a nutshell, when corporate profits are too high above the long-term average, look out.

The BEA (Bureau of Economic Analysis, part of the Department of Commerce) publishes both GDP and corporate profit statistics. A long-term chart of corporate profits/GDP shows the ratio at about 5% during the bad times, and around 6% during the good times. (For a good long-term chart, look at PIMCO's February 2007 Investment Outlook by Bill Gross.)

How about recent history? Well, profits/GDP ranged between 5%-6% from 1998-2002. Then things got out of line - 7.7% in 2004, all the way to over 10% in 2006 and 2007. (These figures from the BEA website, http://www.bea.gov/national/index.htm.)What did this mean to astute observers? (And I don't count myself as one, because I didn't realize this until after the crash!) Corporate profits were too high, were unsustainable, and had to fall - by as much as 50%, in order to return to historical norms. Ouch!

(As an aside, if we did some further math, we could probably have calculated that the excess corporate profits came from low interest rates and too much debt.) The moral of the story - watch the corporate profits/GDP ratio, and when it gets out of line, be careful.