Saturday, March 27, 2010

More on corporate profits

This extends my posts of yesterday on the subject of corporate profits. This chart shows total corporate profits alongside profits from nonfinancial business corporations. Note that the two vertical scales are proportionately calibrated, with nonfinancial domestic profits just about half of total profits. The chart should make it clear that financial sector profits (and losses) have not greatly distorted the total profits picture on balance.

It's interesting to note the huge decline in nonfinancial domestic profits in the wake of the relatively mild 2001 recession, and the far milder drop in those profits during the much more severe 2008-09 recession. I don't have a good explanation for that, but would welcome suggestions.

The above chart compares NIPA profits (total after-tax economic profits of U.S. corporations) with reported operating profits of major corporations. Note how much more stable NIPA profits are than operating profits. I also detect a tendency for NIPA profits to lead operating profits. One reason for that, of course, is that the operating profits ratio is based on trailing four-quarter profits, whereas NIPA profits represent a seasonally-adjusted annual rate for each quarter. We could see some pretty impressive performance in this series over the next year as operating profits catch up to the stronger NIPA profits.


Benjamin Cole said...

Interesting charts-but I do have a quibble about what I think is called the "logarithmic scale" of this last chart.

At first glance, it looks like corporate profits just dipped a little in the last recession, and rebounded.

But after closer examination, we see the scale is "semi-log" or something to that effect, and it is difficult to determine how much profits fell. Not enough notches on the vertical measure.

If any event, I am happy to see corporate profits rising, and it seems they are sitting on a lot of cash these days, and banks have a lot to lend. Investors have huge piles of cash on the sidelines, and many, many people need jobs, and most businesses are operating well under capacity.

Do you think we can get the party started?

Mark Gerber said...

Hi Scott,
Perhaps another factor is that S&P EPS are based on an equal weighted average of the 500 S&P member EPS even though the index price level is based on a market weighted average of the underlying 500 member stock prices. Hard to believe S&P would report aggregate EPS that way, but they do!

John said...


Scott will likely have better answers but one reason why profits did not fall as severly this time may have been the speed of the decline. Remember we had a financial heart attack and needed some fast time on a defibrillator. Businesses slashed expenses (read employees) so quickly that profit declines were more moderate than they might have been. Just my off-the -cuff thought.

It depends on how you want to define the 'party' but it may have already started. The stock market is a leading economic indicator and it is up pretty dramatically in the last year. The unemployment rate probably peaked at a little over 10% last fall. Initial unemployment claims are still high but appear to have rolled over. There are numerous other 'signals' that say the band has arrived. They may still be setting up their instruments but it really should not be too long before we hear some real music!

brodero said...

Over the last 60 years the S&P 500
has traded above the net cash flow
number 44% of the time....of the years that the S&P 500 traded below the Net Cash Flow numbers (
basically 1970 to 1995) it could be
directly related to high inflation rates and high interest rates....the net cash flow number today is was 863 when the
S&P 500 peaked in the first quarter of 2000.

brodero said...

here is a formula...

Take the 3 month average of S&P 500 monthly closes divided it
by the NIPA corporate profits after
tax numbers and multiply it by the
year over year change in the Consumer Price index....when it gets above 5 look out....

Scott Grannis said...

I've add some labels to the y-axis which may address Benjamin's comment. Profits fell by a ton.

Benjamin Cole said...


Let's hope the band knows some heart-pumping hits.

I guess there are always negatives out there.

I am concerned about perma-deficits built into the federal budget, and the chance for more Long-Term Capital Management or AIG-type meltdowns.

These realities may depress investor optimism. I am worried about deficits and financial time-bombs, or weapons of mass destruction, as Warren Buffett calls them. Accordingly, I have migrated my investments into SE Asia farmland (some personal reasons for this too).

On deficits: in the next 10 years, we will spend about $15 trillion on national defense. We have no nation-states that are enemies, sp this spending now represents our "War on Terror," as conducted by Bush and embraced by Obama.

Moreover, this is an open-ended war--it could cost far more. These direct costs do not include VA budgets, and some other smaller spending in other agencies related to defense, and exclude Homeland Security.

I wonder how many terrorists there are connected to Al Queda? A few thousand? 10,000? The high number seems unlikely, as they have to recruit Nigerian nitwits to play pantybomber, but let's go with the higher number of 10,000.

We will spend $15 trillion in the next 10 years, fighting that group of 10,000.

That works out to about $1.5 billion in spending in the next 10 years, per terrorist. What do I know, but it seems like a lot.

And I can assure you of one thing: At the end of that 10 years, the Department of Defense will say there is a terrible specter on the horizon, that requires even more money to be spent. And that their equipment is aging.

That is the nature of federal agencies. They always have a good story to tell why the budget has to go up.

The United States public debt is still below that of some nations, but it headed in the wrong direction. And I see no cure. Other investors must feel the same way--and now the topic is front and center, wih Obama's huge deficits (admittedly, he inherited a financial collapse), and health care program.

Milton Friedman advocated a progressive consumption tax to finance wartime outlays, and it was always his most-favored tax (he did not like taxing income, as it was a tax on productive behavior).

Evidently, we have decided ee are in war, the global war on terror. Bush called himself a "war president." So, many perceive these defense outlays as necessary.

If so, we should listen to Milton Friedman, and adopt a progressive consumption tax to raise the $15 trillion we will spend in the next 10 years.

Somehow I do not think that is going to happen.

So the DJI may have a rocky road ahead.