Corporate Profits: What My #1 Business Indicator Is Predicting Now

by Dr. Mark Skousen, Chairman, Investment U
Monday, March 19, 2007: Issue #651

Recently, I was looking at a variety of economic statistics to see which ones best predict whether we are headed into a boom or recession. Recall that two weeks ago, former Fed chairman Alan Greenspan predicted the possibility of a recession, which caused Wall Street to go into convulsions.

To find out if Greenspan’s prediction made any sense, I took a hard look at historical trends in corporate profits. It turns out that for decades corporate profits have been one of the best forecasters of recessions.

In fact, they are usually the first indicator of trouble, usually peaking a year before a recession officially happens.

Yet oddly enough, the U. S. Leading Economic Indicators Index put out by the Conference Board does not include corporate profits in its list of 10 indicators.

I contacted the Conference Board in New York to find out why, and amazingly, here’s the reason: Corporate profits are released quarterly, and the U.S. Leading Economic Indicators comes out monthly, and so they can’t use corporate profits as an indicator, even though it’s better than most of the other business cycle statistics!

Are Corporate Profits Peaking?

The following graph shows the direction of corporate profits since 2000.

The first thing to note is that real corporate profits started falling before 2001-02 recession, then anticipated the recovery in 2002.

Second, profits have been on a tear since 2002, growing much faster than the overall economy and real wages. In the third quarter of 2006, profit growth was running at an annualized rate of 16%. Is this rate of profit sustainable? Probably not, and there’s already indications that the profit rate will settle into the high single digits this year.

In short, corporate profits are likely to slow this year, and that could be a challenge for Wall Street. Unless interest rates fall, growth stocks are not likely to be the best place to be in 2007. What’s a better choice?

Dividend-paying value stocks and international stocks. I recommend the WisdomTree International Top 100 Dividend Fund (NYSE: DOO). It’s already a winner this year.

Good investing,

Mark

Today’s Investment U Crib Sheet

• Not accounting for corporate profits is just one example of the many methodological problems facing the Conference Board’s Index of Leading Economic Indicators. Another defect is the Consumer Expectations Index, which does little to measure the outlook for consumer or retail sales; it’s more a business conditions indicator.

• While corporate profits have been healthy of late, it’s important to single out companies putting their excess cash to good use. Look for businesses that invest in new-product development, increase their dividends, initiate smart share buyback programs, and improve their balance sheets by paying down debt. Find out how management intends to increase shareholder value by downloading a company’s annual report (10-K) from the “investor relations” section of their website. Here are eight quality businesses paying out significant portions of their profits to shareholders.

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