Earnings are the fundamental source of the value of common stock. Although short-term market movements are unpredictable, in the long-run the market capitalization of companies cannot grow faster than their earnings. On an economy wide basis, furthermore, earnings cannot grow faster than GDP unless the fraction of earnings to GDP continues to rise, which makes no sense economically or politically.
The foregoing implies that to understand the recent behavior of the S&P 500 (.INX), it is useful to take a look at the behavior of the earnings to GDP ratio. Based on data from the Federal Reserve, the chart below plots the ratio of total corporate profits to GDP.
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