We have several economic metrics that we follow very closely at DCM. These indicators give us a peek into the health of the economy and indicate where we may be headed. We want to share three of those indicators with you and provide an overall outlook on current U.S. economic conditions and what they might mean for the stock market for the remainder of 2014.
1. After-tax Profits
The price of the S&P 500 index (blue line/right axis) plotted against after tax profits for the entire U.S. market (red line/left axis), which is measured in trillions of dollars.
Of all the indicators we watch, this one might be the most compelling argument for the strength of U.S. corporations. After-tax profits reached a high around $1.4 trillion in late 2006 before their sharp decline during the Great Recession of 2008-09. Today’s levels are well above where they were pre-2008 and show no signs of slowing down. Companies are operating with incredible efficiency. Many of the companies we follow can produce as much or more than they did prior to the Great Recession with significantly fewer employees. While this hasn’t been good news for employment (more on that in a minute), it is very positive for corporate earnings.
This is the third blog in a series exploring the theories of John Burr Williams. You can read the first post here and second post here.
In Part I of this series, we quoted Arnold Bernhard, founder of the Value-Line Investment Survey, as being an early advocate of the theories of John Burr Williams. He agreed entirely with Mr. Williams’ belief that investors needed a generally accepted valuation criteria. He also joined Williams in warning that the effects of not having such a methodology had resulted in excess stock market and economic volatility over the years that had damaged investor confidence not only in the stock market but also in the free markets.
Bernhard boldly stated,
“In our own experience, during periods of inflation as well as at other times, in this country and abroad, it has been found that dividend-paying ability is the final determinant of the price of a common stock. Whenever, over a period of years, the dividend or the ability to pay dividends, went up; so too did the price of the stock. When the dividend-paying ability went down, so did the price of the stock, inflation or no inflation.”
In applauding John Burr Williams’ theory; however, Bernhard inserted a subtle twist to Mr. Williams’ basic premise by adding the words, “ . . . or the ability to pay dividends.” By adding just these few words, he reentered the world of earnings and left behind the “dividends only” world that Williams had described as so important in determining long-term intrinsic value.
