The first quarter of 2007 is almost in the books. It is still in the air whether the main world stock indices will be in the black for the quarter, and whether bonds or stocks will have the better return. But a bigger question for the markets over the rest of this year is the direction of corporate profits.

Thursday’s revised US gross domestic product figures for the last quarter of 2006 showed GDP growing 2.5 per cent. But pre-tax profits from current production (excluding various accounting adjustments) fell by $4.9bn. Even though post-tax profits rose, thanks to corporate tax cuts, this suggests the share of the economy that goes to corporate profits is finally about to fall from levels that are close to historical highs.

According to Lombard Street Research data, the ratio of non-financial companies’ earnings before income, taxation, depreciation and amortisation to operating assets – a good “raw” measure of corporate profit margins – peaked at 15 per cent in the first quarter of last year, close to the post-war high of 15.8 per cent set in 1966. It has now slipped to 13.9 per cent.

The reduced profit share is not necessarily bad news for the markets. The war between capital and labour is not always a zero-sum game. Privately, and sometimes publicly, senior financial figures are nervous about deepening economic inequality. It brings the risk of a political backlash. And as the subprime debacle shows, there are dangers for everyone in an economy where many live through recession while the rich get richer. Some redressing of the balance is healthy.

But Wall Street will not want to see the profit share fall too much. The current expectation is that this quarter will bring a juddering halt to the streak of 14 consecutive quarters in which S&P 500 companies’ earnings grew 10 per cent or more. According to Thomson Financial, the current consensus is for growth of only 4.4 per cent, far below the 8.7 per cent they forecast three months ago (although still well above the growth rate expected for GDP). So a sharp slowdown in profits should already be embedded in share prices. That will be put to the test, once companies start to announce their earnings.

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