The third look at GDP for the fourth quarter included new data on corporate profits for the non-financial corporate sector (as well as other sectors). As flagged by economists at JP Morgan, profits fell steeply, in part due to one-offs associated with fines levied in the energy patch. If you want detail on that, then I think the econs at JPM are probably the place to go for now.
I noticed that business transfers, a detraction from profits, spiked about $70 billion above trend (when the level is expressed at an annual rate) during the fourth quarter, which fits roughly the estimate JPM had come up with for the fine hit. So to get a sense of the trend, I net that effect out in the chart shown above left, which thus provides a more realistic depiction of the influence of the cycle here. Without my adjustment, the chart looks pretty ugly, full disclosure.
As you can see, profit margins seem to be making a topping “pattern”, at least when measured in the national accounts and applied to the domestic operations of US non financial corporations. There is slippage from here to the S&P data, but the two tend to be correlated, for obvious reasons.
The main source of pressure on profit margins is the rising share of corporate value added taken by labor. This represents a predictable cyclical reversal of what had been a pretty powerful trend. The source of this reversal is the tightening labor market and late-cycle weakness of productivity growth. I know the perma bears will come out and say MEAN REVERSION and maybe even link the fines to that concept. The only way margins could be kept so unnaturally high was by cheating! LOL
Mean reversion is actually a weak force, and we don’t really know where the appropriate “mean” for the current setting is, because the equilibrium level of profit margins can change, something the perma bears just ignore, while expressing their usual supreme confidence.
But yeah, we do seem to be near or past the peak level of profit margins for purely cyclical reasons. And I guess I would concede that those mean reversion forces, weak as they are, would be down, not up. This fits into the idea that medium-term equity returns from here should be quite low, which is my view. Philosophical Economics has done what I humbly would say is the best work on that issue. The market has little upside ahead of the next recession, it would seem. And then it will get crushed immediately ahead of it and during it, if history guides.
That is a lot to read into two charts, obviously. But it is just the context in which I interpret this morning’s numbers. Plus I don’t get paid for these ramblings, so I am not going to assume the stress of guessing the stock market.