The first-quarter earnings season, and the prospect of the softest profit growth in five years, isn't holding back the stock market. About a third of the nation's publicly traded companies have posted their results for the March quarter. Many have reported strong results and are forecasting rising growth, but many are also reporting slowing conditions and offering cautious outlooks. Despite the mixed results, the Dow industrials are up nearly 5 percent so far in April while the S&P 500 index is up just a bit more than 5 percent.

April's stock market rally of course reflects a rebound from declines during the hectic month of March when failures in the subprime mortgage industry raised concern of a chain-reaction in the financial markets and also concern that tightening credit standards would further hurt the housing market. Of course another factor behind the turbulence has been former Federal Reserve Chairman Alan Greenspan who in late February raised the issue of slowing profit growth and the risk of an economic slowdown.

The chart above tracks year-on-year profit growth in the S&P 500. Profits have risen for an impressive 20 straight quarters, though the streak of double-digit percentage gains has come to an end. First Call, which compiles the data, currently pegs first-quarter profit growth at 5.3 percent. The gain is likely to increase slightly, but only slightly, after all the company reports are in. But one very positive indication is at the right of the graph, indicating that analysts, who base their forecasts on company forecasts, see profits returning to double-digit levels as early as the fourth quarter.

But the chart below, which compares S&P 500 profits with the S&P 500 index, does offer a hint of trouble. Even with the stock market's troubles during March, the S&P 500 index still posted a first-quarter year-on-year gain of 8.8 percent. This will prove about 3 percentage points higher than underlying profit growth, perhaps not that significant though the fourth-quarter also saw a 3 percentage point gap. These mark only the third and fourth times during the expansion that year-on-year share-price appreciation has exceeded profit appreciation. It's also, as highlighted by the red arrows, the first back-to-back overshoot on the chart. Given the stock market's current rally and the modest outlook for second-quarter profits, a third straight overshoot may be in the works.

Whatever imbalance may be building in the stock market, it is insignificant compared to the great imbalance going into 2000. The chart below compares the level of the S&P 500 index with total corporate profits as measured by the Commerce Department. The great mountain on the left side of the graph (light green line) reflects the exuberant profit expectations of the period, which peaked in first-quarter 2000 and bottomed as the economy emerged from recession in 2002. Profits interestingly stayed flat through the Y2K period before showing particular softness in 2001, the year of course of the last recession.

But a longer look (graph below) shows that profit slowdowns and recessions don't always match up. A very sharp slowdown in 1998 did precede more than several years of flat profit growth but not an immediate recession. Profits were solid through the early 90s despite the 1990-1 recession, and there was no recession in the mid-80s despite what was a 20 percent year-on-year profit dip heading into the 1987 crash. But sagging profit growth in the early 80s did clearly correspond with the two recessions of that period.

Bottom line

For the investor, headlines of new records for the Dow industrials, and maybe soon the S&P 500 too, may obscure the risk that share prices are accelerating relative to profit growth. Slowing profit growth could also have wider effects, including on the jobs market and the nation's fiscal deficit. Keep an eye out for macro-economic comments from companies during the earnings season and also for comments from policy makers, both current and former, on the profit outlook.