“Stocks Illustrated”

James Pethokoukis puts up the “Chart of the Day” to argue that if the Fed is causing a bubble (the mot du jour) you can´t see in the stock market. This is the chart:

Larry Kudlow loves to say “profits are the mother’s milk of stocks.” Well, the above chart from Jim Paulsen at Well Capital Management shows a stock market both reasonably valued and driven by profits.

That chart brought back memories of stories from long ago. Readers may remember that when the corporate shenanigans, epitomized by the Enron scandal in late 2001, were discovered shortly after 9/11, officials said that the corporate investigations would track back to 1997.  I thought, why 1997? Could it be that suddenly a not so small group of CEOs woke up one morning in 1997 and decided that they really were crooks?

Unlikely. What was the ‘incentive’ for ‘crookery’ that turned up at that time? Notice in the chart above that in mid-1997 profits stopped rising. Kenneth Lay´s, Jeffrey Skilling´s and other´s compensation was closely tied to their stock performance. Although people thought they were brilliant executives, they were just run-of-the-mill greedy mortals. So they cooked the books.

Why did profits stop rising at that particular moment? The Chart below illustrates. While up till then productivity had been running ahead of real compensation that changed, with compensation rising to narrow the gap (and profits).

From the stock market indices and profits charts below, notice that the Dow-Jones, not influenced by the behavior of technology stocks went up an additional 36% before plateauing. The S&P 500 climbed another 58% before turning down when the “tech bubble burst”.

Note also that when the corporate shenanigans were discovered the markets quickly dropped (24% for the S&P and 20% for the Dow). But by that time profits were again on the rise on the back of rising productivity and subdued labor compensation, so the market indices followed suit.

The point here is to show that the stock market is not a casino and to call any and all stock price increase a bubble, as has become fashionable, denotes ‘poor judgment’.

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