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Have Corporate Profits Become Disconnected From Economic Growth?

Dee Gill

In another sign that business really can ignore Congressional gridlock, corporate profits rose to record levels in the fourth quarter of 2012, according to the government tallies released Thursday. That’s important to investors because bullish forecasts for the stock market this year tend to assume that corporations will be able to improve already high profit margins, even if the budget crisis and European economic problems drag on. It’s not an assumption everyone buys.

US Corporate Profits After Tax as % of GDP Chart

Corporate profits rose to 12.4% of gross domestic product in 2012, which is up about 2.5 percentage points from 2011, according to data from the Commerce Department’s Bureau of Economic Analysis.

That fourth quarter gain is particularly impressive considering the uncertainty in the the economy during that period, which included the U.S. presidential election, a very real possibility of huge tax increases and government spending cuts, and serious economic trouble in Eurozone countries. It was a time when many investors assumed things wouldn’t go particularly well for U.S. business, as evidenced by this S&P 500 share price chart below.

^SPX Chart

Some market experts argue that a slowdown in profit margin expansion, or even smaller margins, will depress share price gains this year. Wells Fargo Strategist Gina Martin Adams points out that most of the cost cutting that’s possible has been done in recent years. She hasn’t changed her forecast of the S&P 500 at 1390 by year-end, or about 10% lower than it is today.

Despite her worries, big companies such as General Electric (GE) and Procter & Gamble (PG) continue to squeeze out a wider profit margin as the economic recovery limps along.

Still, is that the best thing for the broader economy? Higher margins often are the result of higher productivity, which lately has come from paying fewer workers less money. Business revenue won’t really boom until more people work and have money to spend.

US Unemployment Rate Chart

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.

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