Fittingly the third quarter sees year-on-year profit growth at, you guessed it, 17 percent. In fact 17.6 percent. The earnings season continues (at this writing about two thirds have reported) and the 17 percent reading may change or may be later revised, but the changes are not likely to be dramatic. Note the gains over the last 17 quarters have been posted against ever more difficult year-on-year comparisons.

The game of expectations management
The tracking of corporate profits -- on a timely basis -- is not captured by standard economic indicators. Corporate profit data compiled by the Commerce Department lag company reports and are calculated differently. Initial readings on third-quarter GDP were issued last week but accompanying data on corporate profits for the same period won't be released until the end of this month. This is where company news comes in.

The light green bars on the graph above are estimates of future profits and are compiled by First Call. They represent the expectations of roughly 500 Wall Street analysts who in turn base their estimates on the publicly stated estimates from the companies they track. Judging by the graph, one might assume profit growth may slow over the next several quarters. And perhaps profits will slow, but low forecasts are part of the usual cat-and-mouse game played by corporate management.

Cat and mouse
Companies have to guard themselves against the speculative exuberance of the stock market, which can badly punish the share price of a company that misses its stated estimate. Managements then, in an effort to stack the expectation cards in their favor, are typically conservative in their outlooks. Going into the latest quarter, for instance, S&P 500 profit growth was expected to be no better than 10 to 11 percent, well under the 17 percent results being posted. The roughly 7 percent spread is definitely on the high side, comparing with a typical 3 percent expectation spread over the course of the current 17 quarter run. First Call uses the spread as a secondary indication of profit health, offering for us a further indication of strength. This game can also be measured by the percentage of companies that beat estimates, in this case a very strong 75 percent vs. a recent average of 60 percent. The remaining 25 percent in the latest quarter are roughly split between companies that have done no better than meet their estimates and, sadly, those that have actually missed.

12,000 or not, the malaise remains
Remember back if you will to the days of Y2K and earlier when Alan Greenspan was warning of "irrational exuberance." Perhaps I was the one elbowing you in the Charles Schwab line. Those were times when there was an opposite play between profits and share prices, when share appreciation greatly exceeded profit growth as will be seen in the final graphs of this short take. The graph below shows the ongoing play between profits and shares.

The green bars are the same as the first graph, representing year-on-year S&P 500 profit growth. The orange bars are year-on-year changes in the S&P 500 index. The left side of the graph shows that the index was contracting even while profit growth was emerging. Growth between profits and stocks then matches up well in late 2003 and early 2004 before stocks begin to lag again. Stock growth has in fact lagged now for 10 straight quarters up to the third quarter where the bars are highlighted. The graph suggests, at the least, that speculative excess is not a threat to the stock market.

A change in the air?
Confidence in the stock market has been shaken badly over the past several years. Arguably the stock market's biggest set back was the dotcom bubble, dramatically teaching us the lesson against speculative excess. The Nasdaq composite, home to technology start ups, is a living reminder of the bubble. The index, at the time that the Dow is hitting record highs, is still under half its March 2000 peak. The crash has been followed by a long and continuing run of accounting scandals. The war against terrorism also may be having an effect, turning our attention away from financial investment and inward to home & hearth.

The graph above offers a wider look at profits and stocks. The green line is profits as measured by the Commerce Department, showing mostly steady levels before rising sharply following the 2001 recession. The red line is the S&P 500 index, showing a large bubble from 1997 to 2002. Stocks then match up in line with profits before beginning to lag in late 2004. The final graph is the same story but told over the last 40 years, a comparison that even more dramatically shows the extent of the Y2K bubble.