Monday, July 16, 2012

Headwinds for Corporate Profits

The conditions that drove corporate profits to record heights have weakened or reversed, yet analysts still expect year-over-year growth above 10%. Based on what?

Corporate earnings are expected to resume their rapid rise after the "summer soft spot." Zero Hedge recently published The Impossible Earnings Season Stepfunction which included this chart of profit growth expectations:

If we look at corporate profits, we notice they have skyrocketed since late 2009. Can they continue this trajectory into the stratosphere?

Correlation isn't causation, but it probably isn't coincidence that profits rose as savings plummeted, consumer credit expanded and the dollar weakened. Here is another look at corporate profits. Note they shot to unprecedented levels in the 2000s as debt rose and the savings rate dropped to near-zero.

Corporate profits plunged in 2008 when savings jumped higher.

Household debt broke away from wages in the early 1980s, and the gap widened until 2009.

The debt was not evenly distributed; the bottom 95% loaded up on debt to compensate for stagnating earnings while the top 5% saw their relative debt burden fall as their earnings rose smartly.

Virtually all the earnings growth in the past 40 years flowed to the top 10% and the majority went to the top 5%, so the rise in wages shown in the above chart is deceptive: most of that increase flowed to the top 5%. (See Financialization and Crony Capitalism Have Gutted the Middle Class July 13, 2012)

As I have often noted, a weakening dollar greatly boosts the overseas profits of U.S. multinational corporations. One euro in profit in 2002 = 1 dollar of profit. A few years later, 1 euro in profit = $1.60 in profits when stated in dollars. That 60% increase was entirely the result of currency valuations.

Now that the dollars is in an uptrend, what was a tailwind since early 2010 is now a stiff headwind to overseas profits for American corporations. Since many major corporations book 40%-50% of their revenues overseas, this is a non-trivial influence.

Is it coincidence that year-over-year earnings growth declined as the U.S. dollar gained against the euro and other currencies? If it boosted profits on the way down, it must suppress them on the way up.

Can corporate profits shoot to the moon in a global recession? Given the headwinds of a bottomed-out savings rates, moribund consumer credit and a rising dollar, it's difficult to imagine profits maintaining the trajectory imagined by analysts for late 2012 and 2013.

The conditions that drove profits to record heights have weakened or reversed, so it's quite a stretch to conjure up continued quarterly gains above 10%.

Corrected link: my apologies for the dead link published in the latest Musings Report. Here is the correct link: Is the Web Driving Us Mad? New research says the Internet can make us lonely and depressed—and may even create more extreme forms of mental illness.

Three new videos with CHS and Gordon T. Long of Macro Analytics:
Central Planning
Statism Part 1
Statism, Part 2:

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Rather than being powerless, we hold the fundamental building blocks of power. We need neither permission nor political change to liberate ourselves. A powerless individual becomes powerful when he renounces the lies and complicity that enable the doomed Status Quo’s dominance.

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