Chart of the Day: Corporate Profits vs the S&P 500

I’ve made a big fuss over QE in recent years and yet the market continues to plough higher.  I often have people ask me:

“Why does QE make stock prices go higher if there’s no fundamental impact?”

My answer is always the same.  First, look at Europe where QE has also been implemented and stock markets like Greece, Italy and Spain have been decimated.  Then look at a country like the USA where QE has been implemented and yet stocks soar.  Then ask yourself what the big difference is between these countries?  The answer: austerity versus massive deficit spending.

It might be easy to scoff at such an observation, but the reality of the picture is that corporate profits have been largely driven by the deficit in this cycle.  As net investment collapsed the traditional driver of profits was overtaken by government spending (see figure 1).  This makes sense if you’re familiar with Kalecki and his profits equation.  It makes even more sense if you’d been working under Richard Koo’s balance sheet recession theory in recent years.  The impact of government deficit spending in such an environment has been massive.  All those people screaming about the ill effects of deficit spending and hyperinflation in recent years missed the very explainable and fundamental driver of the profits momentum.

This doesn’t mean QE did nothing (I think it helped to some degree), but it doesn’t mean it was the primary driver of the recovery by any means.  In fact, the risk of QE is the disequilirbium I often talk of where market become disjointed when compared to profits.  And when people ask me if QE is resulting in some disequilibrium, I often tell them that it hasn’t necessarily resulted in that outcome yet.  But with stocks rising nearly every day and soon outpacing the trajectory of corporate profits (see figure 2) there’s no reason to think that we can’t reach a level of disequilibrium in the next few years (or maybe even less).


(Figure 1 – Corporate Profits Breakdown via Orcam Investment Research)


(Figure 2 – Corporate Profits vs S&P 500)


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • LVG

    “All those people screaming about the ill effects of deficit spending and hyperinflation in recent years missed the very explainable and fundamental driver of the profits momentum.”

    You mean the Zero Hedges of the world who have gotten nearly everything wrong?

  • Nils

    QE in Europe? Do you mean LTRO?

  • bb


    Is chart 2 a little misleading?

    The S&P 500 is effectively a “per share” series.

    Corporate profits are not.

    Or am I reading it incorrectly?

  • SS

    The LTRO is QE by a different name and slightly differing implementation.

  • Alberto

    Deficit spending is feeding the corporations and their shareholders, but corporations are not managed by stupid people, they know that 1) deficit spending is not forever 2) purchasing power of the american people is not increasing 3) technology improvements are the other driver of growth but it is not increasing the job pool, quite the contrary, just some jobs are doing well. Therefore, we’re not observing a decisive rump up in investments and there is no real quality job creation now and even less in the near future. I can’t say for how much longer this will last but corporate earning will revert to the mean. But of course “this time is different”, is the favourite sport in town.

  • Nils

    Slighty? I’d say it’s significantly different, owing to the difference in monetary systems.

  • SMOB

    Slightly off topic but what would youre reply be to those who say that after the DoTCom bubble burst and the German private secter deleverged so the ECB dropped rates to 2% thus allowing the other EU countries to borrow cheap but they did not manage this opertunity its well and caused wage rises and property bubbles so they should pay for it now?

    Some hold the view that those other government had poor planing (ghost towns and airports and bridges in Spain and Portugal costing billions to link a town filled with goats) need to pay for that mismanagement when the Germans needed to deleverge?

  • Notagain

    i enojoy this is site but i think some of your explanations are getting a bit wonky Cullen .i dont get the sense that you have the answer but i do get the sense that you want to think you have the answer ..this is not intectually honest ..

  • Nils

    “This time is different” is not what I’m hearing. Quite the opposite. Every week there is a new crisis, every day I hear “this will end badly”, everyone is astonished and voicing disbelief at this market action. All the while I’m making easy money. If I were to follow news and valuations I’d be broke. To plagiarize an old platitude: “The market can seem irrational longer than you can stay solvent”.

  • Chad M

    QE has had a very large psychological effect. The belief among investors that the Fed (now BOJ) will do whatever it takes to ensure asset prices rise drives investors to put cash to work. Fundamentals really haven’t meant much for years now. If they did, people would take note of the fact revenue hasn’t grown much and most of the eps gains over the last two years have been driven by cost cutting measures and little talked about share buybacks. Supply is being taken out of the marketplace and that helps drive stocks higher as well as corporate bottom lines.

  • Alberto

    I’m not totally out of the market but I’ve reduced my risky positions quite a lot and I’m increasing my long treasuries every time 30 yeld goes higher than X%. I’m not selling PM nor shorting them, the drums of war in the middle east are not totally silent, I don’t believe that Japan will do any better than in the past and the euro zone will break up. There were in the past much better conditions for the germans to accept some form of euro bonds and they did nothing, they preferred to keep the put option. The costs of keeping the euro will sooner or later be higher than the advantages of keeping it.

  • Conventional Wisdumb

    Will it be different this time?
    What returns can we expect from the stock market?
    As of today, the Total Market Index is at $ 16745 billion, which is about 106.1% of the last reported GDP. The US stock market is positioned for an average annualized return of 2.8%, estimated from the historical valuations of the stock market. This includes the returns from the dividends, currently yielding at 2%.
    As pointed by Warren Buffett, the percentage of total market cap (TMC) relative to the US GNP is “probably the best single measure of where valuations stand at any given moment.”

    Over the long term, the returns from stock market are determined by these factors:

  • Anonymous


    Any financial professional who believes in asset allocation and portfolio rebalancing would be committing professional negligence if they were not advising their clients to be net sellers of equities.

  • jjames

    government spending?

    this rally is all about the federal reserve giving free money to the banks to buy stocks.

    if the fed even utters a word about stopping qe or, god forbid, raising interest rates, the market tumbles.

    austerity has nothing to do with it.

  • Alex Gloy

    So corporate profits trended lower from 1997 to 2000, but rose during the 2001 recession? Sounds implausible.

  • Andrea Malagoli

    In other research, corporate profits have also come out of a massive squeeze in costs out of the employee basis (see e.g. corporate profits vs wages). Revenue growth has not kept up nearly as much as profits growth.

    Yes, the bears have been wrong for a long time. However, we also know that the Keynesian solution of massive deficits spending also hardly ever works in the long run.

    Your pictures point to the US becoming another Japan …

  • jjames

    the data in those graphs is also highly questionable. so your saying that if government money is spent on the military, it makes the homebuilders and banks more profitable?

  • jjames

    yes, and profits also rose during the the recession of 2000 and the market crash of 2000-2003. lol

  • jjames

    becoming? we’re there.

  • Tom Brown

    “this rally is all about the federal reserve giving free money to the banks to buy stocks.”

    If you’re talking about QE, that’s not what happens. QE doesn’t change anybody’s equity position. Here’s a simple set of balance sheets illustrating this fact:

  • jjames

    the fed is simply buying bonds, both treasury and mortgaged backed securities(at who knows what price), and with money it does not have.

    net result result, more welfare to the banks, not to mention the 0% rates.

    why do you think the market rallied yesterday?

  • JGF

    I don’t quite understand how to interpret Figure 1. Too much information packed into a single plot (and colors are too similar) for my brain to process. Could you (or someone else) describe, say, what the right-most set of lines say (quantitatively) about the make-up of corporate profits?

    Also, I’m not sure I see the disequilibrium trend between profits and S&P500. Just looking at the ratio between the two:

    … things don’t look out-of-whack today.

  • JGF

    Above comment should have included this graph:

  • Tom Brown

    “money it does not have”

    Reserves are ALWAYS a liability to the Fed.

    This doesn’t change the fact that nobody’s equity position changes. The Fed mostly buys T-bonds and it doesn’t pay other than a market rate for them. The banks don’t suddenly have more capital with which to make risky investments afterwards. There may be more deposits in the hands of investors, but their equity doesn’t change either. However, investors, unconstrained by regulator capital constraints as the banks are, may decide to take on riskier investments.

    To say it’s about “giving away free money to the banks” is a misrepresentation. If the Fed were to actually do that, then the banks’ equity and capital positions would improve.

  • Anonymous1

    You read my mind,lol! The lower graph profits/S&p looks as though it’s fairly valued, the upper graph is a maze that needs a clarification. Could someone clarify why are several line items listed as “savings”?

  • Nils

    At the very least one could pick up some cheap protection. Might be hard to convince the client though.

  • jjames

    there an old saying, figures lie, and liars figure. i guess it makes sense that if you give welfare to banks, they become profitable, although it may only result in a small improvement in the overall economy.

    according to this chart, anytime the government spends a dollar on anything, it helps even industries that are completely unrelated to where the government spent the money.

    its also tells you the government generally runs higher deficits when the economy is slow and tax revenues are lower.

  • jjames

    sir, if i buy your junk(mortgage backed securities) i think you’d be richer.

    and markets prices fluctuate based on demand, that includes bonds.

  • Alberto

    This is a key point. A stock has infinite duration if all goes well but any firm can go burst. So when the projected return of S&P 500 is less than the 30y treasury well for me the treasury bond is much much better.

  • Alberto

    right. Where the stock market will be 24 months from now, I don’t know but I’m pretty sure we’re going to see 10y yeld below 1% and 30y yeld close to 2%. I will put my money where my mouth is.

  • Alberto

    let me say an unpopular thing. When the government subsides big banks and big corps (expecially the broken ones) with trillions of dollars all is right. When the gov tries to subside the green economy or public schools with a few billions we will hear a lot of screams. This country is broken, when to take a degree in engineering a brilliant young american has to make debts for 200.000 dollars while a young brilliant chinese receives it almost free you should know what country will rule in the near future.

  • Anonymous

    Thanks, Tom Brown, for adding real understanding, not the uninformed time wasters.

  • Nils

    Nothing of this is particularly new information though. There will probably come a day when a lot of what is ignored comes back to haunt us. Since I don’t know when that is, all I can really do is mentally prepare for a big drawdown and a change of strategy.

  • Tom Brown

    Thanks! QE certainly has some effects. It grows bank BSs and has a marginal effect on asset prices, but it’s not like they’re just sending out free reserves.

  • Nils

    “Richer” by a negligible amount, it changes the duration of the seller’s portfolio.

  • http://pragcap Michael Schofield

    I know QE is less than the ideal way to do things, but in the case of Japan, a weaker currency will do more for them than us since they’re so export dependant. And anyway, the market seems to think Japan is “printing money” (LOL) so the short yen, long exporters trade is working. Sooner or later this trade will unravel, but don’t they all?

  • Nils

    If you pay 200k for credentials you are probably not that brilliant ;)

  • csodak

    What happens to stock prices when Wall Streets the “i” value falls approaches or drops below 1?

  • csodak

    restated….What happens to stock prices when Wall Streets “i” component in their DCF model falls approaches or drops below 1?

  • Tom Brown

    This explains the first chart:

    However, I don’t completely follow that explanation.

  • Cullen Roche
  • Tom Brown

    I’d love to set up a simple macro economy example, with the minimal number of actors… just enough to show examples of all this stuff on their balance sheets.

    Then dive in and explain JKH sentences like these:

    “Business gross profit = undistributed gross profit + distributed profit”

    “FS = business saving = undistributed gross profit (depreciation plus retained earnings)”

    “All equations hold net of depreciation as well, when specifications for I and S reflects that level of netting”

    And show how different events map to different parts of that chart.

    I certainly wouldn’t be able to do that now, given my current level of understanding.

  • Tom Brown

    Cullen, I added up the figures in the table (“Exhibit 6″) in that link two ways, and I still didn’t arrive at the figure they got for profit.

    1.) Just added the right hand column, except the last row: 3.2-3.4-7.6-2.7+5.5 = -5

    2.) Apply the sign in front of the description (left had column) to each row before adding:
    3.2-(-3.4)-(-7.6)-(-2.7)+5.5 = 22.4

    How do you arrive at a profit of 10.2% with those figures?

    Normally for percentages, I’d convert to factors and then multiply instead, but for small percentages that should be approximately the same as adding them. Example: yesterday I lost 5% but today I gained 12%. How did I do over two days?:

    (1 – 0.05)*(1 + 0.12) = 1.064 = 6.4% gain (exact)

    100*(0.12 – 0.05) = 7% gain (approximate)

    I’m not sure the multiplicative approach even applies here, but it doesn’t really matter since both answers above are WAY off, so what’s wrong?

  • Cullen Roche

    Here are the exact figures from Q4 2012.

    NI 0.032622136
    PS -0.03545
    GOVT 0.07762
    Foreign -0.02743
    Dividends 0.05563

    Sum: 10.2%

  • Tom Brown

    Thanks…. so it appears that the GOVT row has a sign error in the table.

  • Cullen Roche

    That’s Montier’s table, but I think he just intends it to be used as a double negative. Would be better to just describe it as govt dissaving and then the math on the table I recreated makes a lot more sense.

  • Tom Brown

    I figured that must be the case with one or more rows… I only had 30 more permutations to try out to find the inconsistent signs! ;)

  • Tom Brown

    Ah, you’re right. He does have a double negative there!

  • CharlesD

    Summary as I see it:

    Net Investment (after depreciation) (I)creates profits because the
    buyer of the inventory, equipment, building, etc. incurs no income statement charge. However, the seller receives the revenue, resulting in profits on the seller’s income statement.

    Net Exports (NE) create business revenues with no increase in net costs, hence profits. Of course, the US is an importer so this is
    a drag on profits.

    Consumers spending more than their wages (C) adds to corporate revenues with no increase in corporate costs – hence profits. If you add dividends to consumer income you can simplify the chart.

    Finally, when the government spends more than it taxes – a deficit (D) – this money becomes a corporate revenue with no increase in corporate costs – hence a corporate profit.

    Overall, then – After-tax Profits = I + NE + C + D , as defined above.

    Despite widespread beliefs to the contrary, “cost cutting” has little or no impact on profits. One business’s lower costs is another business’s lower revenue. Hence, the overall impact on profits of “lower costs” is a “wash”. The same holds true for productivity. While changes in productivity are of utmost importance to our standard of living, it can be demonstrated with simple math (I won’t do it here) that changes in productivity have no direct impact on profits. Hence, “cost cutting” and productivity are not in the “profit equation”.

    Hope that’s helpful.

  • Mark A. Sadowski

    There’s two very big problems with this story:

    1) General government spending has barely changed in the eurozone, falling from 51.2% to 49.3% as a percent of GDP from 2009 to 2012 whereas in the US it has undergone a much larger contraction falling from 44.2% to 40.6% of GDP over the same time period. (Via the IMF database.)

    2) The ECB’s balance sheet only increased from 1.46 trillion euro in September 2008 to 2.65 trillion euro currently (about an 80% increase) whereas the Fed’s balance sheet has increased from $930 billion to $3.23 trillion over the same period (about a 250% increase). (Via the ECB and the Fed.)

    In reality US has done both far more fiscal austerity and far more QE than the eurozone.

  • Cullen Roche

    Let’s be more specific then. For instance, in Greece, govt spending has fallen 25% from its 2008 average levels whereas it’s only declined 6% in the USA.

    I’ll give you the point on the ECB vs the Fed, but I am not sure it matters as much as you think.

  • Nils

    It would be awesome if there was some website where you can preserve your predictions for posterity. If there isn’t already such a thing I might actually build it for the fun of it.

    Anyways, are you anticipating some sort of Japan like trajectory (todays 30 year JGB auction had a yield of ~150bps)?

  • Mark A. Sadowski

    But that is the incorrect level of comparison.

    I’m sure that we can find individual states in the “dollarzone” where total government spending (including federal) has decreased significantly more than the US average but that’s totally irrelevant. We are talking about monetary policy after all, and the correct level of comparison is between the currency areas themselves.

  • GYSC

    I guess I just don’t get why we have gone through 50 years of cycles if all we need is deficit spending and QE unlimited to make us all rich. I mean, how come this took so long? You economist types are not that smart if it took this long to figure out ;)

  • Cullen Roche

    Right, but those states (like Mississipi for instance) obtain huge amounts of Federal funding. Greece has no such mechanism so when their state spending falls 26% during a balance sheet recession their corporations get crushed.

  • Cullen Roche

    I don’t think you’re seeing the entire picture. When aggregate demand is too low the govt can pick up the slack to help us avoid a major catastrophic recession as is presently happening in places like Greece. But if the govt were to keep this up it would cause very high inflation and be self defeating. Better to think of high deficits as a temporary aid. It’s like a man who has a heart attack. He needs help temporarily until he gets back on his own two feet.

  • Explorer

    So about what is he wrong and why? To be credible you need data, evidence and arguments in support of your proposition, not just feelings.

  • GYSC

    Ok, then what is “Temporary”? Hussman gave a recent talk and stated QE was on until 2025 at least or something to that effect. Leave that aside as too out there, is 4 years temporary? 8 ? Look, I used to be into things finance really heavy duty. Yours is one of the few sites (that number gets smaller everyday) that I still read because of the great insight and great comments section. Let’s define temporary in terms other than “until things improve”. Japan will be the lesson I guess.

  • Cullen Roche

    Well, if my reasoning is right (that it’s the budget deficit that matters more than QE) and (Jan Hatzius is also right) then the deficit will be MUCH smaller come 2015 which means the economy will likely turn weaker as we roll into 2014/15. If I had to peg odds on a recession in the 24 month period I’d be inclined to take the over on 50%.

  • GYSC

    Hatzius is a great thinker. Interesting point, in what way is the deficit to be less? In the new second derivitive contrarian world, a recession may push the S&P to 2000 or so :)

  • Mark A. Sadowski

    Well then, let’s look at the flip side of this question.

    In aggregate, general government spending hasn’t fallen much in the eurozone. This means that there are probably countries where general government spending has increased, and in some cases, increased substantially. Moreover, as you note, eurozone countries that are dong well are much less fettered by the burden of supplying fiscal transfers to countries that are doing poorly. If QE isn’t responsible for the increase in the stock market indicies then we should see equal if not greater increases in their national stock market indicies when compared to the US, where by comparison there has been a substantial decrease in general government spending.

    According to the IMF database, Luxembourg, Austria and France have seen their general government spending increase by 6.5%, 3.5% and 2.4% respectively in real terms between 2009 and 2012.

    (I chose three countries of various sizes with their own stock markets. As a matter of fact ten of the 17 eurozone members have had general government spending increase in real terms over this period, unlike the US.)

    The LUXXX, ATX and CAC 40 stock indicies are up approximately 50%, 75% and 50% respectively from their lows in March 2009. This stands in stark contrast to the 135% increase recorded by the S&P 500 over the same time period. Thus it seems to me that differences in fiscal policy are not very important in explaining differences in stock market performance.

  • Cullen Roche

    Well, I think the fiscal policy and lack of transfers have played a larger role than you’re giving credit for. The nations you mention have all expanded spending or run current account surpluses and their markets are higher while the peripheral countries like Greece, Portugal and Spain have all had their markets crash 50%-90% from the 2007 highs while running austerity programs.

  • Will

    Where does the personal saving data come from? In fact, where does all the data come from? It would be great if you could provide an excel spreadsheet or source….

  • Johnny Evers

    Deficit spending is structural, a result of increased obligations for the state and federal governments to pay for health care and defense.
    It is *not* a response to the recession. Yes, there was a stimulus, and yes tax revenues were down, but when you look closely at the numbers, you see that the deficits are being driven mainly by increased federal spending.
    So the idea that the deficits are going to fall in the coming years if the economy improves … well, that’s conjecture at best and wishful thinking at worst.
    We talk about an economy being based on ‘output,’ but what do you do when you have so many obligations to support those who don’t produce output. Maybe you can issue debt for a while, but eventually the rest of us must either produce more or consume less.

  • Paul Clee

    You are being very active commenting…when you seem to be missing a few points (as Tom Brown pointed out).
    If I might say…

  • Mark A. Sadowski

    Yes, Luxembourg, Austria and France are doing *better* than Greece, Portugal and Spain (which with Ireland are the only countries in the eurozone that have cut general government spending by more in real terms than the US from 2009-2012, and which together represent less than 18% of the eurozone GDP). The point however is that they are all doing *worse* than the US despite more expansionary fiscal policy. In fact none of the major eurozone national stock indicies are outperforming the S&P 500 (not even the DAX).

    So far only five countries in the eurozone have not had a second or third recession since 2008: Austria, Estonia, Finland, Germany and Slovakia. And the real GDP of Austria, Finland and Germany contracted in 2012Q4. Based on the PMIs from the first three months of the year, Austria and Germany are very likely in a second recession (I can only guess about Finland). Thus the relatively poor performance of eurozone stock markets reflects the relatively poor performance of their real economies.

    But, notably, fiscal austerity has only been practiced in earnest in Greece, Ireland, Portugal and Spain. Take a look at Figure 15 for example:

    Other than the countries named above, only Slovakia has cut spending in discretionary terms more than than the US between 2009 and 2012 and only the Netherlands and Belgium have increased taxes in discretionary terms more. And Belgium, Finland and the Netherlands have not cut spending at all, and Finland, Germany and Slovakia have actually cut taxes.

    So to reiterate:
    1) The eurozone has done very little QE compared to the US
    2) The great majority of the eurozone has done less fiscal austerity than the US, with some members having done none at all (e.g. Finland).
    3) Yet the US is virtually outperforming every single member of the eurozone with respect to stock market performance and in real economic terms

    Of course I think the periphery would be performing better with an automatic fiscal transfer mechanism (and Peter Kenen argued this was an essential part of an Optimum Currency Area all the way back in 1969). But that would simply be spreading the pain more evenly. This is clearly all about the lack of monetary stimulus.

  • CharlesD

    While I haven’t done it myself, I’ve seen an analyst put all this
    data into a spreadsheet (savings, investment, state and local deficits,
    federal deficits, et) and come up with total corporate profits which
    tied in with NIPA profits (Natiional Income and Product Accounts)
    I believe all the data also came from NIPA.

    Two important nuances: because of stock buybacks, corporate profits per
    share have been growing more quickly than corporate profits (add 2% or
    so to the growth rate). These numbers, of course, refer to total

    Second, to the extent you are following the S&P 500, for example,
    S&P profits can diverge from total profits. In recent years, S&P
    profits have grown more strongly than total profits. I’m not sure
    why this is the case – perhaps Home Depot, etc (which is in the S&P)
    is putting the small hardware store out of business (which is in
    total profits), etc.

    Hope this is helpful.