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Economy: For months now, many investors and Wall Street analysts have wondered how the major stock market indexes can keep climbing higher into record territory when the economy is growing at a slow 2% pace. But it’s really no mystery: Profits, the fuel for rising stock prices, are growing.
Make no mistake, earnings are strong right now. Quoting FactSet, the Wall Street Journal reported Monday that 73% of the S&P 500 companies that had reported earnings as of last week had posted results that exceeded forecasts for both revenues and earnings.
Earnings for S&P 500 companies rose 15% in the first quarter and are likely to grow at double-digits again in the second quarter, based on incoming data, the fastest growth in six years.
This is not an accident or fluke.
New products continue to emerge from the tech industry, many based on entirely new technologies. Meanwhile, whole new industries, such as the “Gig Economy” of Uber, Lyft, Air BnB and others, not to mention fracking, have sprung up nearly overnight.
Yet, there may be one other major reason for rising earnings.
In recent months, despite the ongoing political chaos and drama of the Trump White House, the new president has started the U.S. down a path toward potentially substantial economic growth.
Yes, GDP growth at 2.6% in the second quarter is still slow. Some have even been so bold to suggest that this shows the markets are in the grips of a kind of mania, since, they argue, stock prices keep rising above all conventional gauges that suggest caution is in order.
As Shawn Tully of Fortune Magazine recently correctly noted, “corporate profits have averaged 7.5% of GDP since 1951. Today, they absorb 9.2% of national income. How about margins? They’re lofty as well. For the Fortune 500, the ratio of profits to sales was 7.4% in 2016, more than 2 points higher than the average,” and the fourth highest ever.
OK. But maybe, just maybe, the rising profits and the stock market are telling us more about the future than the slow GDP data are telling us.
GDP as an indicator actually lags changes in the real economy. It’s a rearview-mirror gauge. So what’s actually happening now in the economy, though not fully recognized, will often be felt in later quarters and years.
If that’s the case, profits may be telling us that future GDP growth will be much higher than it is today. Three-percent growth? It’s possible.
Along with all the private-sector innovations we noted above, some of President Trump’s policies are starting to gain traction, despite the near-daily Soap Opera of the Trump White House that has occupied media attention.
Let’s start with probably the least-heralded of all Trump’s accomplishments so far: His deregulation of significant parts of the economy.
Regulation today imposes a nearly $2 trillion burden on the economy, recent estimates show. So even small changes can have a big impact.
Since coming into office, Trump has cut 16 old regulations for each new regulation added. His Labor Department is now considering, for instance, eliminating the Obama administration’s overtime rule, which cost small businesses billions of dollars and discouraged hiring of full-time workers.
Then there’s energy policy. By loosening federal limits on oil exploration, greenlighting new pipelines and jerking the leash on the EPA’s excessively stringent rules, and walking away from the absurdly costly Paris Agreement on climate change, the energy market is experiencing a renaissance that Democrats — including President Obama — just years ago deemed impossible.
Using new technologies and operating with a new-found sense that the government wants the energy industry to thrive, the U.S. has become the world’s No. 1 energy producer and is starting to sell its surplus overseas.
These things, along with low inflation, still-low interest rates and continued cost-cutting by American firms, have pushed profits higher.
And here’s the surprise: there might be room for even more profit growth as the economy expands.
Two major items on Trump’s agenda — tax reform and the repeal and replacement of ObamaCare — have yet to be passed. Both could potentially have an enormous impact on companies’ bottom lines and on future investment.
For example, just ending the current tax punishment of profits overseas could lead to much of the $2.4 trillion in retained earnings now held in foreign corporate accounts returning to the U.S. as investment and dividends for investors.
Businesses are already responding to the changes. For the first two quarters of this year, business investments in equipment, intellectual property and construction grew smartly. That’s fuel for future GDP growth, future jobs, future wage hikes and, yes, future profit growth.
We’re not Pollyannas, and we don’t make predictions about the stock market. That’s a fool’s game. Many things can happen, both good and bad, to alter the outlook for markets and the economy.
Yet, for those who are wondering why the market keeps going up when the economy is so weak — and why businesses seem to be so optimistic — there’s this: It’s all about rising profits. They’re no mirage, they’re very real.