Market Overview

Is Capitalism Broken? Corporate Profits in a Slow-Growth Environment


While there are certainly many complaints that is broken, such is not the case. Yes, there are problems with economic inequalities, the majority of which can be directly traced to monetary and fiscal policies and a rise in However, that is a discussion for another article.

In the economy today, capitalism is alive and well. The reason we know this is due to both the surge in inflation and corporate profitability since 2020. If was broken, as the economy was flooded with $5 trillion in fiscal stimulus, inflation would not have resulted. To wit:

With the economy shut down and an inorganic surge in demand due tothe selling prices of a restricted supply of goods rose. The basic economic function of supply and demand proves capitalism is functioning properly. Furthermore, as shown, corporate profits surged with labor costs greatly reduced due to the shutdown and higher prices due to artificially stimulated demand.

Supply-Demand Chart

NIPA Corporate Profits

Lastly, if as many suggest, stock market prices would not have chased higher corporate profits. In a capitalistic market environment, investors should place a higher valuation on companies with increased profits. Such is precisely what we saw in 2020 and 2021 as investors began to overpay for current profits. As is always the case, is a byproduct of capitalism.

Cumulative Change: Profits vs Market

However, corporate profits must also fall if capitalism has not become broken.

What Are You Going to Do for Me Now

Let’s revisit how we got that massive surge in corporate profits.

Not surprisingly, with labor costs sharply reduced and households flush with cash to spend and nothing else to do, combined with an inventory shortfall to meet demand, the result was a sharp increase in profitability. The data from the NFIB small business survey confirms that as labor costs continue to rise, corporate profits will fall.

NIPA Profit Margins vs NFIB Compensation Plans

So, suppose the combination of a shuttered economy, no supply, and massive rounds of fiscal stimulus got us here. What is going to be the catalyst to support record profits in the future?

Over the next few years, the environment looks markedly different than in the past.

If you agree with that premise, you must agree that AS .” Therefore, corporate profits, and by extension earnings, must revert to accommodate slower economic growth. The current near-record deviation of corporate earnings from the long-term exponential growth trend remains problematic for bullish investors currently.

Earnings Deviation From Growth Trend

Capitalism Remains Detached

It is certainly understandable why people think capitalism has become broken. They feel unfairly treated as the labor providers to the capital providers. The chart below of profits to wages makes the argument.

Wages to Profits Ratio

However, the very definition of capitalism is that chart:

In other words, if you are feeling slighted by the current economy, then you have three choices:

  1. , or

The problem is that corporate profitability and the market remain detached from the underlying economy due to the massive interventions over the last decade. Such makes forward returns on providing the means of production and market investments more problematic.

Historically, such deviations don’t work out well for overly investors. The correlation is more evident when looking at the market versus the ratio of corporate profits to GDP. Why profits? Because for IRS tax purposes, corporations report which are much less subject to manipulation than

Real S&P 500 Price vs GDP to Profits

With correlations at 90%, the relationship between economic growth, earnings, and corporate profits should be evident. Hence, neither should the eventual reversion in both series. Currently, the S&P 500 index is trading well above its historical trend in earnings. As corporate profits decline, the current earnings estimates will also decrease.

Real Price vs Real Earnings

No. Capitalism has not become broken. However, the detachment of the stock market from underlying profitability guarantees poor future outcomes for investors. But, as has always been the case, Wall Street is always late in catching up with economic realities.

Such is particularly the case of surging stocks against a weakening economy, reduced global liquidity, and rising inflation. While investors cling to thethe Fed has everything under control, there is more than a reasonable chance they don’t.


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