ETN Eaton Corp New

Friday's dismal GDP data -- particularly the downward revisions to prior quarters -- has even the most bullish of market strategists (myself included) starting to wonder about the increased probability of a double-dip into recession territory.

Normally, to check my biases, I try to ask myself tough questions that assume I could be wrong about the continued strength of the recovery. Last month, I laid out very simple and clear arguments for said continuation in "The Seven C's of Recovery Optimism."

Then, just when I needed it most, a very pointed question came across my radar this morning that is a good counterpoint to my optimism and that must be addressed. Writing on SeekingAlpha Sunday, G.C. Mays proposed that "The Relationship Between Corporate Profits and U.S. GDP Growth Appears to Have Ended."

The Global Economy's Changing Dynamics

Mays draws on the last ten years of data to paint the picture of a divergence he calls "astonishing." Here is his summary of that picture:

"Between the first Quarter of 2001 and 2006, a simple correlation showed that corporate profits explained 98.4 percent of domestic GDP growth. However, the most recent five years beginning with the first quarter of 2006 the correlation between corporate profits and domestic GDP growth breaks down as corporate profits only explain 10.1 percent of domestic GDP growth."

Mays seems to understand well the not-so-mysterious force behind this evolving disconnect. He explains that with over 45% of S&P 500 company sales coming from outside the US, lots of corporate profits are not entering into the GDP calculation.

"This is due primarily to the growing middle class in emerging and developing markets," he says. Exactly what I have been preaching as blessing for the past two years.

One Man's Bearish Data Is Another Man's...

So while I was at first alarmed by his thesis -- and thinking there was some terrible structural problem with our economy, similar to the credit bubble of the last decade -- I was relieved to find that what Mays finds to be a problem, I welcome as an unstoppable reality of the global economy that, while not perfect, is fueling growth and opportunity for billions of people.

What's wrong with Emerging Markets fueling growth? According to Mays it's that American companies are essentially creating jobs and demand in these economies via a cheaper labor source. And he believes this is ultimately bad for the US economy and its work force.

I'm not smart enough to know whether or not he's right about that. I just accept the reality that if manufacturers like Caterpillar (CAT), Eaton (ETN), Deere (DE), and Cummins (CMI) can find opportunity in countries that want to grow their cities and economies -- and that have billions of people clamoring for the fruits and lifestyles of the developed world -- then who am I to say it's not right?

Progress is certainly still profitable and if we can make money following a historic mega-trend that benefits billions of people searching for a better life, I'm all about that. The opportunities will only grow for the rest of this decade as the world's population surges to 9 billion by 2050.

For more I've recently written on this topic and these stocks, see these articles:

Front-Running the Elephants from July 27

Industrial Strength Power from July 25

Disclosure: I am short puts on Cummins (CMI).

Kevin Cook is a Senior Stock Strategist for Zacks.com
 
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