US national accounts revisions released on Friday show that, relative to their levels at the start of the recession, real GDP is lower and the price level higher than previously estimated. The less favourable output / inflation mix could be interpreted as negative news for equities.

The statisticians, however, simultaneously revised up corporate profits substantially, with a corresponding reduction in personal income. The level of “economic” profits in the first quarter of 2011 is 10% higher than previously estimated – see first chart. (Economic profits adjust for stock appreciation and are based on “true” rather than stated depreciation.)

A national accounts-based measure of the P/E on equities can be derived by dividing the market value of stocks by post-tax economic profits. This measure was previously above its long-run average at the end of the first quarter but is now exactly in line, reflecting the upward profits revision – second chart.

Equity market bears argue that the current level of profits is unsustainable because margins are unusually high and will revert to their long-run average. Historically, however, the initial decline in margins from a peak is usually associated with strong economic growth that boosts employment and labour incomes. Such a development now would probably be greeted with relief by investors fearful of another recession, suggesting an upward rerating of the P/E ratio that would outweigh any weakness in “E”.