You used the word “sustain” in your question, so I decided to take a long-term approach to exploring your suggestions. To do so, I compare the various growth numbers you talked about versus equity prices, looking at the % changes of each over 4 years. What I found was interesting. Strong long-term bull markets tend to occur when real GDP growth is accelerating (see left chart). While the relationship is less perfect before the 80s, in the last three cycles it is seems that GDP growth is a coincident indicator for equities (as such it does not provide a great heads-up for money managers, but it does appear to be a necessary characteristic for a sustained bull market). It is interesting to note here, however, that the acceleration in real GDP during the last bull market was rather tame compared to the market rally.  I think that can partly be explained by the fact that equities were simply pricing super cheap in 2003, and thus they had a lot of catching up to do.  Secondly, and perhaps more importantly, that period saw incredible strides in globalization and thus a lot of S&P profits were being found outside of the US, where the growth acceleration was much greater (e.g., in emerging markets).  Hopefully, this rally can find legs based on similar supports—i.e., attractive valuations and a rebound in trade and globalization (but if there is to be hope of this, policymakers must not botch it with protectionist measures!).  Changes in unemployment track that of GDP very closely, so the relationship to equity performance is also similar (i.e., it also tends to be a coincident indicator from a long-term perspective).

What was particularly interesting, and surprising, to me was the apparent relationship between profit growth and equity performance. Again taking a long-term perspective (4yr % change), it looks like profits tend to lead equity prices by about 2 years (again, this is particularly true in the last three cycles—in each case profits peaked about 2 years before equity markets). To show this, in the right chart, I push profits forward 2 years. Frankly, I am surprised to see such a long delay. In fact, I thought equity prices were supposed to anticipate profits, and if wrong, adjust to them within a quarter or two (when results are known). But even if I take the 1 year rate of changes of profits and equity prices, I again find a common 2 year lag. Perhaps modern monetary policy and credit cycles allow asset prices to proceed with their current trajectory for two years after the fundamentals have started to change? Is this showing the irrational exuberance and then irrational panic now characterizing our market cycles?  As I said, I am surprised by this apparent relationship, so I welcome feedback from clients on this.

 

 

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Thank you very much for your detailed and cogent response. Your analysis here shows profits lead growth, the equity market and employment.  To me, this suggests the pre-requisite to any of the above are, indeed, profits.  Given the corporate process of investment and employment planning I don't find it too surprising there is a lag.