Please, No Middling Profits!

Since 1950, future stock market returns are best when corporate profits are either significantly below trendline (as they are today) or significantly above. But do poorly when profits are middling.

Chart 1 illustrates the total level of U.S. corporate profits (blue line) relative to its trendline average (red dotted line derived from a regression of the log of profits against time from 1950 to date).  Since WWII, U.S. profits have regularly trended higher, but as shown, sometimes they have been way above trend, sometimes way below, and sometimes they have simply been middling.   Turns out, the overall performance of the S&P 500 index depends importantly on the “state of U.S. profits” – high, low, or middling.