Research.LeutholdGroup

Years preceding presidential elections are more likely than others to feature stock-price action that is favorably disconnected from the fundamentals. Since 1926, the average S&P 500 gain in a pre-election year is +14.2%—about double the next-best year of the cycle.

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The scene in our neighborhood in the last two summers has become one of relaxed and well-tanned professionals out in their yards overseeing home improvement and landscaping projects. No surprise: Not a single one has told us they’re less productive when working from home!

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NIPA’s “all-economy” profit margin declined a bit in Q4—which typically peaks before SPX profits—and that falloff coincided with the economy officially reaching full employment, based on the CBO’s Nominal GDP Output Gap. When the Output Gap has flipped positive (like in Q4), corporate profit margins usually come under immediate pressure.

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With consumer price inflation raging at 6.2% and few indications of an imminent rollover, Jay Powell has waved the white flag and retired the ill-begotten “transitory” descriptor. The timing of Powell’s concession is intriguing—perhaps he’s a fellow follower of a simple inflation model: the Output Gap.

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How high can corporate profit margins go? The third quarter saw a new record of 11.0% in NIPA “all economy” after-tax margins, and figures for the S&P 500, due out in a few weeks, will also set a record.

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Last year the Federal Reserve dumped historic stimulus onto a full-employment economy and an already richly-valued stock market. The stock market obviously loved it.

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While the economy’s move above its full-employment level carries reliably negative implications for profit margins, the impact on equity returns has varied greatly from cycle to cycle.

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