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With the final revision to Q1/10 GDP released today, we see a nice upward revision to corporate profits, which were already pretty strong to begin with. In the top chart the blue line reflects total after-tax corporate profits, while the red line shows the profits of nonfinancial domestic corporations. Note how the latter has surged by 83% since the low of late 2008; this means that your average home-grown company's profits have nearly doubled since the depths of the recent recession. That the red line has risen proportionately more than the blue means that the profits of financial corporations have lagged, which is not surprising given all the problems in the banking sector.
Pessimists would be quick to note that profits are now almost as high, relative to GDP, as they have ever been, and thus there is nowhere to go in the future but down. I would counter that by noting that corporate profits have doubled since 1998, long before the equity market reached bubble territory, but equity valuations as measured by the S&P 500 have not risen at all in the intervening years on net. I think this makes a strong case for stocks being undervalued today, depressed by, among other things, a) fears of a double-dip recession, b) anticipated future tax hikes, c) increased government regulation, and d) worries over how the Fed is going to unwind $1 trillion of monetary stimulus. It's not a secret that there are all sorts of problems out there, and there is no shortage of things to worry about these days. These numbers suggest that the market has already discounted a lot of problems, if not all of them. So if anything starts to move in a positive direction (e.g., the November election results in a big mandate to cut spending and avoid tax hikes), then the market should have plenty of upside potential.
20 comments:
Scoot-
I realize that Redleaf and Vigilante contend there is a lot of "dumb money" out there, but does anyone really believe that that the R-Party will cut the deficit?
Based on the historical record 2000-2006? When they controlled both Houses, the Oval Office and the Supreme Court?
Or based on the fevered promises and flag-waving we will soon see?
Some of the best reading I have seen yet.
http://mises.org/daily/3788
Neither Keynesian nor Monetarist interventionistas are part of the solution. In fact, they are the problem.
"The experience of 1920–1921 reinforces the contention of genuine free-market economists that government intervention is a hindrance to economic recovery. It is not in spite of the absence of fiscal and monetary stimulus that the economy recovered from the 1920–1921 depression. It is because those things were avoided that recovery came."
I have always contended the root of our problems begin and end with the Fed.
Without the Fed, the Keynesians do not have the money to spend and the Central bank would lack the ability to distort the allocation of capital via artificial credit expansion.
The rise of the Tea Party is good evidence that there has been a sea-change in the mood of the electorate. Newly elected politicians are going to have a strong bias to cutting or holding the line on spending and not raising taxes. This is the new mandate. It's as if the Libertarian Party has slapped the Republicans in the face, force the Reps to move to the right fiscally. Conservative fiscal policy now dominates the discussions among Republicans; social policies are taking a back seat for the time being. I think the people are going to demand that the Reps become more fiscally conservative. And think of all the old-timers, the big spenders who have been kicked out or are on their way out (e.g., Reid, Boxer, Dodd).
Compared to what we have now, I'd go back to the deficits we had 2000-2006 any day.
The GOP Congress will face an uphill battle, however, because the chances of taking the Senate are slim, and they will still have to battle with Benji's socialist boyfriend.
Just the thought of Washington facing gridlock after the November elections is music to my ears.
The Tea Party does not talk about the unwinding of the Federal Reserve which is truly the root of the problem.
Despite fiscal restraint, eventually the Federal Reserve will induce spenders, savers, and producers into distorted activities via artificial credit expansion.
The value of money drives behavior at the fundamental level. You get the price of money wrong, the whole system goes out of whack.
The Fed does not posses the ability to get the price of money correct. No collective of human being does.
The sooner we understand this, the more quickly we can move to a sustainable future. This is a two-pronged problem. Profligate spending is a symptom of Federal Reserve activity. They are not mutually exclusive.
Scott,
Agree completely. Look at the rockstar status Chris Christie has gained since taking office.
Public: I'd be among the first to say that the Fed has not done a good job. But you have to admit that the inflation statistics haven't been nearly as bad as the would need to be to say that the Fed has failed us. And they have not necessarily facilitated deficit spending. If they had, we would have seen significant monetary expansion and much more inflation.
You know, Charlie Brown believed each year he would kick that football that Lucy held. You guys believe each time that the Republican Party will fight deficits.
The Republicans Party survives on deficits---patronage to the Red Bloc of rural states, defense-security outlays and tax cuts.
Remember, Kentucky gets back $1.51 for every dollar it sends to DC. It is a typical Red State.
Okay, this year I promise, promise, promise not to take the football away.....
Benji,
It boggles the mind how you can be so
obtuse after the staggering amounts of debt your boyfriend and the Pelosi Democrats have run up, and are projected to spend. All the GOP has to do is not be Obama and that will be an improvement.
Paul-
I hope you are right. Still, we have seen the R-Party propose and then run huge deficits even in strong economies--even when they held working majorities in House and Senate.
Why do you think that the R-Party, in a weak economy, will balance the budget? On the basis of what track record?
It has been a long time since Eisenhower and Dirksen were calling the shots.
Let me stir the pot and say that there is no reason at all for the US government to run a balanced budget. In fact, I think there is a good case to be made for never allowing the deficit to fall below a certain level relative to GDP. A deficit of about 2-3% of GDP every year would be optimal. Why? Because that would keep the Treasury market liquid and reliable, and the world's capital markets need a risk-free benchmark like Treasuries to function well. Plus, the world is willing to pay a premium for Treasuries. The benefits of all this would outweigh the costs.
"Why do you think that the R-Party, in a weak economy, will balance the budget?"
I don't necessarily, at least not right away, especially with Obama in charge. But they'll at least take us a few steps back from the volcano's edge Obama is pushing us towards.
"Still, we have seen the R-Party propose and then run huge deficits even in strong economies--even when they held working majorities in House and Senate."
We saw receipts decline during the Clinton recession that began in 2000. The economy boomed after that and the deficit was brought down to 1.2% of GDP in FY 2007, smaller than the historical avg. Still, you won't see me arguing that Bush didn't whiz away too much money on failed liberal programs. But far better than Obama.
"It has been a long time since Eisenhower and Dirksen were calling the shots."
But not that long since Gingrich was holding Clinton's feet to the fire. And the current GOP overall voted against the stimulus, Obamacare, and several of his other
mega-billion dollar gimmicky programs that solve nothing.
On the basis of that track record.
I disagree Scott. In a perfect world yes, however, maintaining 2-3% debt limit is nigh impossible. Ask Europe how their 3% debt cap is working out.
Government will create any excuse to stray from the mark.
Scott-
Oh, jeez, the "deficits don't matter" chorus, a Republican mantra every time they get control of DC.
So, then, why are Obama's deficits so terrible, coming as they do, in the nadir of a worst recession we have seen since before WWII?
Were you not bemoaning all the capital sucked out of the private sector by the Obama deficits just yesterday? Right from the mouths of private business, ready to invest and build new enterprise? Now, you discover global capital markets?
You are calling for a deficit in the $400 to $500 billion range.
You know, the Clinton years were great, high growth, low inflation, and we paid down the public debt relative to GDP that whole time. We even ran federal surpluses. That gave tremendous confidence to financial markets, as did the smart leadership of Rubin-Clinton. (That strumpet-poltroon Gingrich had nothing to do with it).
The US economy also grew nicely after WWII, when we consistently paid down public debt relative to GDP.
Some say fiscal policy is not too important, that monetary policy is everything. It may be that Fed policy is too tight now. There is an interesting blog named Money Illusion, written by a right-wing business prof, that holds to that view.
Maybe. I would be more comfortable paying down debt as a fraction of GDP. You can actually do that if you borrow about $300 billion or less, and the economy grows a bit, Some inflation would also help.
"So, then, why are Obama's deficits so terrible, coming as they do, in the nadir of a worst recession we have seen since before WWII?"
Here you go, Benji, feast your eyes on this and see if you can figure it out for yourself.
"That gave tremendous confidence to financial markets, as did the smart leadership of Rubin-Clinton. (That strumpet-poltroon Gingrich had nothing to do with it)."
Really? Because I remember the budget showdown of '95 between the "extremist" Gingrich budget cuts and the Clinton agenda. I also remember the dot com/Y2k bubble creating unsustainable increase in activity/tax receipts that crashed in 2000 while Clinton was still president.
Hi Scott,
Why do you think corporate profits as a percent of GDP have been above average for the past couple of decades? What are the key macro variables that impact this ratio?
Thanks,
Mark
If I understand this posting's idea, corporations are now making money again, and so we should all be happy, is that right? The problem is that when corporations became very profitable during the early 2000's, the "people" including the middle-class kept getting poorer. Now, I am all for corporations making money, absolutely. But, I am also all for the people. Whether we like it or not, the people will not stand for extended austerity, and make no mistake about, the people have been in austerity now for a decade. Likewise, the government will never default on its debts and therefore, risk losing its precious borrowing power. That leaves only one way forward -- monetary expansion and stimulus leading to growth, and yes inflation. The good news is that inflation has the power to rout government spending and debt via the inflation mechanism itself. But yes, inflation is destructive of savings. But like it or not, austerity is not selling to the people -- default is out of the question -- and so monetary expansion is imminent -- we should all be talking about how to defend ourselves and our wealth against those realities rather than engaging in wishful thinking that austerity is somehow going to be forced on the people.
The "proserity is right around the corner" trick lost the people's vote during the early 1930's and lead to four terms of FDR and the "new deal." To think that the American people have somehow changed since would be naive. More at:
http://wjmc.blogspot.com/2010/06/coming-inflation.html
As an aside, I very much enjoy this blog and consider its views carefully. Thank you for the opportunity to comment...
wjmc: I'm not sure I agree with your suggestion that profits are a zero-sum game (i.e., when corporations get rich the people suffer). Corporate profits are the lifeblood of the economy. Without profits businesses cannot function, grow, or hire. Profits help direct the economy's resources to their best and highest uses. Rising profits are a sign that businesses are more productive, and profits are likely to be spent on more productive investments and new jobs in the future.
Unfortunately businesses are apparently not very eager to reinvest their profits in new plant and equipment. The investment climate is not very good under the Obama administration, which happens to be very anti-business and pro-government. Obama believes deep down inside that government can actually do things a lot better than the private sector, and he is eager to grab corporate profits for his own purposes. This is the big problem we face, not austerity.
I have been trying to point out that "austerity" is not really the right word for downsizing government. A growing public sector is like a cancer on the country, so shrinking it should be beneficial. We would all be better off if we cut government spending programs and transfer payments. There would be some pains of course, but it would be for the greater good of the country.
Inflation can indeed wipe out the burden of debt, but that is really the worst way to get out of a debt problem. I've seen the consequences of such a course of action many times in Argentina. It's awful, especially since it hurts the "little people" much more than it does the fat cats, since the average guy on the street doesn't know how to protect himself very well from inflation, and wages always lag when there is monetary inflation.
I am concerned that the Fed will end up boosting inflation, but so far it hasn't happened. I am hopeful that the mood of the country has turned in support of spending reductions, and against tax increases. Increasing taxes is the worst form of austerity, since it puts the burden on the people when it should be borne by the government.
Scott,
I would your like your thoughts on what happens if/when the federal and state governments are forced to lay off all the employees making six figure salaries who probably can't come close to making that much in the private sector if they can even find a job there. If they are forced out of their middle to upper middle-class lifestyles, doesn't that ultimately hurt the economy? I know you believe money is better spent in the private sector but what do we do with all the people who are thrown out of public sector jobs? Do you really think the private sector can absorb them or that they will form their own businesses? I think we need to think hard about whether one of the benefits of these government jobs is stability in society that we might not have if we just displace all these people. If you can figure out a way to make them productive in the private sector that's great. If not, then we might be in for a lot of trouble.
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