The Double-Edged Sword of Investor Prosperity

The real story so far this earnings season is the strength of large- cap companies who are enjoying excellent profit growth. With the exception of some retailers and small parts of the manufacturing sector, business at most large-cap companies is very good.

Longtime readers of this column know that I like to follow a number of large-cap companies to help get a feel for the overall direction of the stock market and the economy. Many of these bellwether stocks are reporting solid growth in earnings, and this is during a period when the gross domestic product (GDP) has been very slow.

General Electric Co. (NYSE/GE) reported excellent numbers in its second quarter, and the stock is trading at a new 52-week high. Hewlett-Packard Co. (NYSE/HPQ) hasn’t reported its second- quarter numbers yet, but this stock is also trading at a new 52-week high. In fact, this stock has gone up over 50% in the last year. Not bad for a company whose market capitalization is $124 billion.

Another bellwether that I like to follow is IBM Corp. (NYSE/IBM). This stock is getting closer and closer to its all-time high, which was set in the tech craziness of 1999. Johnson & Johnson (NYSE/JNJ) just reported a 13% increase in its second- quarter revenues. Profits rose nine percent during the quarter, and it’s likely the stock will set an all-time record high this year.

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Finally, there’s Merrill Lynch & Co. (NYSE/MER) which is always a great read on the health of the capital markets. If Merrill Lynch is making money, so (usually) is everyone else. This company’s second-quarter profits rose just over 30% on strong investment banking and brokerage fees. The stock is once again due for another two-for-one stock split.

So, with the GDP in the first half of this year being the slowest in years and corporate profits doing exceptionally well, it looks like the current rally in stocks will last. I still think we’ll get a correction in the not-too-distant future, and with all the money that’s being made by large-cap companies, I don’t think the economy can escape the inflation bug. Prosperity is most definitely a double-edged sword.