Over the long haul, profits rise at much the same rate as GDP. If we pick our way through some ancient data releases, we find that, since 1950, nominal corporate profits and nominal GDP have both grown at an almost identical compound annualised rate: 6.5% and 6.4%, respectively. The slightly higher rate for profits reflects its currently higher-than-normal share of GDP. Profits have of course been far more volatile than GDP, rising and falling at more extreme levels. For example, between the end of 2006 and the end of 2008, pre-tax corporate profits fell by 37%, whereas nominal GDP actually rose by 3.7%. Profits then quickly moved ahead and caught up with the GDP growth rate.
The US share market is in an effervescent mood. We have little doubt that growth expectations for the economy and corporate profits have attained levels that simply cannot be achieved over the long term. It is inevitable that the US and rest of the advanced world will experience lower GDP growth in the future compared with the past 60-70 years, largely thanks to demographic factors.
It is also worth reflecting on the extraordinary level of share buybacks in the US in recent times. According to S&P Dow Jones Indices, S&P 500 buybacks totalled $806.4bn in 2018, up 55.3% year over year, and up 36.9% from the 2007 record of $589.1bn. By 2009, buybacks had collapsed to just $137.6 billion. If stock markets are truly prescient, buybacks should have been almost non-existent in 2007 but racing ahead in 2009. We guess that answers that question.