Is This The Top? First Quarter Corporate Profits Tumble Most Since Lehman

Tyler Durden's picture




 

As SocGen's Albert Edwards conveniently points out, during the excitement of the downward revision of Q1 US GDP from +0.1% to -1.0% investors seem not to have noticed a $213bn, 10% annualized slump in the US Bureau of Economic Analysis's (BEA) favored measure of whole economy profits, defined as profits from current production. Also known as economic profits, the BEA makes adjustments to remove inventory profits (IVA) and to put depreciation on an economic instead of a tax basis (CCAdj). Edwards shows the stark difference between the BEA's calculation for post-tax headline profits (up 5.3% yoy) and economic profits (down 6.8% yoy) in the chart below. In short: the plunge in actual corporate profits in Q1 was the biggest since Lehman!

 

It is not just SocGen's bear who observes this surprising finding: Goldman is on it as well.

Last Thursday's second release of the Q1 national accounts showed a 14% decline in the BEA's measure of adjusted, after-tax corporate profits. In just one quarter, profit margins dropped from 10% to 8.7% of GNP.... The chart on the left of Exhibit 1 shows that the Q1 dip in profit margins was unusually large. As the chart on the right shows, the decline was felt across-the-board, with corporate profits in the domestic financial sector suffering the sharpest drop and domestic non-financial and rest-of-the-world profits showing large declines as well. In addition, corporate taxes rose as a share of profits, accounting for about one-tenth of the decline in after-tax profits.

 

Goldman is quick to note two reason why it hopes this inflection point does not signal the end of record profit margins:

  1. The decline was driven by statistical adjustment factors. The first reason is that the decline in corporate profits as measured in the national accounts mostly reflects the capital consumption adjustment factor estimated by the BEA to account for the effect of the expiration of bonus depreciation at the end of 2013.
  2. Q1 weakness should be temporary. Growth and productivity were unusually weak in Q1, which likely weighed on profits, but both should strengthen going forward. As we argued recently, Q1 weakness was mostly driven by temporary factors, while more recent data suggest that the acceleration is intact.

What is most perplexing is that while corporate profits will eventually decline it is expected that they will do so at the expense of rising wages. This is not happening: To wit: "Wage growth remains soft. Our wage tracker--an aggregate of average hourly earnings, the employment cost index, and nonfarm business compensation per hour--rose only modestly in 2014Q1 to 1.8%. As we previously noted, this is about 2 percentage points below the rate at which labor costs would begin to consistently eat into profit margins."

If anything this is confirmation that there is far less slack in the economy than widely believed, and that corporate profitability can collapse even without a comparable increase in much needed wage inflation (the basis for David Rosenberg's conversion from a deflationist to inflationist).

So Goldman spin aside, what is really happening? For the real answer we go back to Albert Edwards who is kind enough to explain:

Having spent the best part of 25 years following US whole economy profits I feel I have a good understanding on what exactly is going on. I was however most surprised at the divergence in the two key series shown on the front page chart. After a very long chat with a very helpful person from the BEA, she emailed me to “note this quarter, there is a substantial difference between profits from current production (that include IVA and CCAdj) and profits before tax (that exclude IVA and CCAdj) due to the expiration of investment incentives that allowed companies to accelerate depreciation over the past several years. As provisions of the tax acts from 2002, 2003, 2008, 2009, 2010, and 2012 expire, and as no new provisions are introduced, businesses are now expensing less depreciation for tax purposes. As a result, tax based depreciation expense, measured as CCA, is falling, while economic depreciation expense, measured as CFC, continues on a steady growth trend (see charts below). The difference between these two measures is the CCAdj. With economic depreciation expense higher than tax based depreciation expense, BEA’s measure of corporate profits with CCAdj shows a decline, while profits excluding CCAdj show an increase.”

The punchline: "headline reported profits are currently artificially inflated upwards to show a roughly 5% yoy increase, which is incidentally the same pace that the MSCI trailing reported stockmarket profits are rising by - both are misleading investors as to the underlying strength of profits."

Or, said simply: accounting gimmicks relating to the tax treatment of accelerate depreciation managed to boost paper, not real, profits artificially higher. And now that the gimmick is no longer there, profits are finally reverting to a reality-based trendline.

But wait it gets worse: when looking at pure cash flow - the hardest to fudge corporate data point - the chart speaks volumes:

Edwards again:

The BEA press release itself describes net cashflow with IVA as “the internal funds available to corporations for investment (calculated as after tax profits with IVA and CCAdj, net of dividend payments but plus depreciation on an economic basis (CFC))”. We can see from the chart above that this decreased by $132bn in Q1 following a decrease of $43bn in Q4. This key measure of internal funds available for investment has stalled badly over the last two years (see chart above). No wonder US business investment has been struggling recently. The bottom line is that the US profits margin cycle has begun to turn down at long last (see chart below). It is doing so from elevated but not unprecedented levels - especially the nonfinancial part of the economy (my former colleague Leo Doyle always told me I had to add depreciation into the profits numerator as the denominator GDP was also measured gross of depreciation - i.e. the G in GDP!)

And visually - this chart is comparable to the Goldman one, only it looks at GDP not GNP and has profits on a pre-tax, not after-tax basis.

 

But why did nobody notice this earlier? We go back to Edwards for one final time:

Just about everyone I know, except my wife, has seen the Star Wars films and knows the scene when Obe Wan gets through a stormtrooper checkpoint using his Jedi powers -

Stormtrooper: Let me see your identification.

Obi-Wan: [with a small wave of his hand] You don't need to see his identification.

Stormtrooper: We don't need to see his identification.

Obi-Wan: These aren't the droids you're looking for.

Stormtrooper: These aren't the droids we're looking for.

Obi-Wan: He can go about his business.

Stormtrooper: You can go about your business.

Obi-Wan: Move along.

Stormtrooper: Move along... move along.

As Obi Wan might have said, "US Profits are not declining. China is not devaluing. There is nothing to see here. Move along and continue to party."

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Tue, 06/03/2014 - 08:54 | 4819728 Temporalist
Temporalist's picture

"These are not the drones you are looking for." -Obama Want Yourliberty

Tue, 06/03/2014 - 09:08 | 4819761 knukles
knukles's picture

Old Chinee saying; "If pigs could float."

 

Yangtze go home!

Tue, 06/03/2014 - 09:17 | 4819788 TeamDepends
TeamDepends's picture

Is this the top?  Yes.  Yes it is.

Tue, 06/03/2014 - 09:18 | 4819791 SMG
SMG's picture

I still say the only data point that matters is "Is the Fed printing today?".

Tue, 06/03/2014 - 09:30 | 4819825 SafelyGraze
SafelyGraze's picture

corporate profits down? 

if only there were a way to reduce recurring costs.

http://wallstcheatsheet.com/business/4-companies-replacing-people-with-m...

Tue, 06/03/2014 - 09:40 | 4819852 Ben Ghazi
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As long as my EBT card and Obamaphone still work, I don't give a fuck!

Tue, 06/03/2014 - 09:43 | 4819859 doomandbloom
doomandbloom's picture

Not now...i am expecting Q2, 2015.

Will be aiming to get out of dodge by then.....

why? dunno...just pulled it out of my ass like other analysts

Tue, 06/03/2014 - 10:16 | 4819927 Son of Loki
Son of Loki's picture

I thought "BEA" stood for "Baloney et al?"

Tue, 06/03/2014 - 10:28 | 4819954 Honey Badger
Honey Badger's picture

Relax everyone, the bad 1Q was weather related.

Tue, 06/03/2014 - 11:26 | 4820157 economics9698
economics9698's picture

Ben Bernanke was reincarnated.  In his former life he was John Law.

Tue, 06/03/2014 - 12:41 | 4820430 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

Dear CBs worldwide,

   Even as you clowns have printed money like no tomorrow, my future does not look any better. It is time to burn the cities down.

-pissed off sheeples

Tue, 06/03/2014 - 12:13 | 4820315 flacon
flacon's picture

Would somebody PLEASE stop the weather! 

Tue, 06/03/2014 - 17:59 | 4821357 Whootie_who
Whootie_who's picture

Obama is going to try that with a50%  carbon tax... that will stop the climate from changing or vankrupt Amerika

Tue, 06/03/2014 - 11:46 | 4820220 Raging Debate
Raging Debate's picture

Many investors learn the hard way not to exact time market movements. I myself will look at stocks again in 2016. I don't expect a massive correction as others do, 10% but that will send ripple effects based on lack of confidence out into the economy. I will avoid index investing and brokers doing company specific due diligence. It wont make me rich overnight that is for sure those days are at a close for many years out.

One bright spot, I do expect oil price decline after the summer.

Real growth is happening at .5 percent after population growth but that kind of recovery feels like wilting not exuberance.

Tue, 06/03/2014 - 09:43 | 4819861 Lewshine
Lewshine's picture

Don't need consumers, don't need housing, don't need Europe, Russia, China. Don't need retail, don't need profits, do't need sales - All you need...Is the Fed.

Quit wasting time and space. This goes on forever.

Tue, 06/03/2014 - 11:28 | 4820165 economics9698
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"Quit wasting time and space. This goes on forever."

And forget about factoring inflation, it does not exsist.

Tue, 06/03/2014 - 09:54 | 4819882 TheRideNeverEnds
TheRideNeverEnds's picture

Top?!?

 

Hahahahahahaha  no

 

BTFD, its free money; we are going higher.

Tue, 06/03/2014 - 10:55 | 4820026 TeamDepends
TeamDepends's picture

Go ahead and laugh, but some of you are missing a key point:  Nobody wants our shit-stained FRNs anymore!  Sure they'll print more and "the markets" (ha) might inch slightly higher from here, but we stand by this prediction.  If you are not making final preparations, what exactly are you waiting for?http://www.youtube.com/watch?v=daAdB6fSzhU

Did not junk you.

 

 

Tue, 06/03/2014 - 11:12 | 4820117 TheRideNeverEnds
TheRideNeverEnds's picture

Maybe so but I have hedged my long USDs with an assload of long EUR, VIX, Miners, and Silver so if past perfomance is any indication of future results; Metals, VIX, and EUR are all going to zero as the spoos reach escape velocity on their way to the moon. 

Tue, 06/03/2014 - 11:37 | 4820194 dontgoforit
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If you can't stand the truth, arrest the truth-tellers.

Tue, 06/03/2014 - 09:20 | 4819795 philipat
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"Old Chinee saying; "If pigs could float."

Knuks, must be true, bacon is up?....

Tue, 06/03/2014 - 09:27 | 4819816 dontgoforit
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Woman who fly upside down, sure to have crack-up.

Tue, 06/03/2014 - 09:34 | 4819836 Dr. Richard Head
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He who goes to bed with itchy butt wake up with stinky finger.

Tue, 06/03/2014 - 09:43 | 4819863 Hulk
Hulk's picture

"The journey of a floating pig begins with a single dump truck"

Tue, 06/03/2014 - 10:41 | 4820004 dontgoforit
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Man who get laid in strawberry patch, sure to have ass in jam.

Tue, 06/03/2014 - 11:05 | 4820098 Dr. Richard Head
Dr. Richard Head's picture

He who farts in church sits in his own pew.

Man who stands on toilet, high on pot.

Tue, 06/03/2014 - 11:10 | 4820111 dontgoforit
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Bank that prints with too much ink, sure to have red bottom.

Tue, 06/03/2014 - 12:17 | 4820331 Senseless Urina...
Senseless Urinal Cake's picture

Man who run in front of car get tired.

Man who run in back of car get gassed.

Tue, 06/03/2014 - 12:26 | 4820362 marathonman
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.

Tue, 06/03/2014 - 09:28 | 4819817 JenkinsLane
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My favourite old Chinese sayings are:

 

"Man who gets up crack of dawn is not necessarily baker."

"Man who walk with hands in pockets is feeling cocky."

 

Tue, 06/03/2014 - 11:03 | 4820091 813kml
813kml's picture

"Man who walk with hands in pockets is feeling cocky."

I heard it as:  "Man with hole in pocket feel cocky all day."

Tue, 06/03/2014 - 11:30 | 4820171 disabledvet
disabledvet's picture

Man with cell phone in pocket always happy.

Man with cell phone in bed even happier.

Tue, 06/03/2014 - 10:23 | 4819940 barre-de-rire
Tue, 06/03/2014 - 14:08 | 4820732 venturen
venturen's picture

nope just a money printer jam...just double and double again....inflation hence "profit" will never go down!

Tue, 06/03/2014 - 08:55 | 4819730 J S Bach
J S Bach's picture

"Bad News" usually means the market will rise... PMs will fall. Just you watch.

Tue, 06/03/2014 - 09:01 | 4819742 MeMongo
MeMongo's picture

Sadly Bach you're probably right! But if Mongo sees $8 silver again I swear I will sell every...well not " every" other tangible asset that I own and will go balls deep in that shiny little stuff:-)

Tue, 06/03/2014 - 09:29 | 4819805 spine001
spine001's picture

Listen to Yellen's last Congressional testimony. She said that if conditions deteriorate they will restart QE. Henceforth, she is buying all investors a put into the market. It can't go down, no matter what, except the FED going down in flames, possible, but unlikely in the medium term. Furthermore Yellen can not do anything else, since she can not allow the value of collateral to come down, given that leveraged on a real tiny amount, the whole house of cards is financially siiting on it. Imagine if this tiny foundation were to shrink. It'd be game over and they will never allow it, no matter the inflation level. Inflation will not destroy the system. Collateral collapse would, thus it can not be allowed to happen. And this is how they think.

What is the limit? Your guess is as good as mine, the argentineans managed to survive without going out into chaos more than 10 to the 13th x inflation in the last 30 years. They experienced minibursts, but nothing major as some of you expect. The state came outmore powerful than ever.

And all along the market grew and grew, of ncourse if you picked the companies that didn't go belly up. The second best investment was unimprove undeveloped land. The third, way behind was gold with us dollars the fourth. That is, of course if you don't take into account the money making ability of well invested capital. During this period fortunes were made and lost. The fortunes made were mostly made through corruption and chronyism. Very few were made through real value contribution to society. 

 

Tue, 06/03/2014 - 09:37 | 4819843 Oldwood
Oldwood's picture

Thats the new economic paradigm...if you ain't stealing you ain't earning.

Only a fool would work for a living.

Destruction is upon us.

Tue, 06/03/2014 - 10:32 | 4819949 Ben Ghazi
Ben Ghazi's picture

Get to work fools!

 

My EBT card needs funds on it next month too   -   Duh!

Tue, 06/03/2014 - 10:40 | 4820001 Meat Hammer
Meat Hammer's picture

Only a fool would work for a living.

Oldwood, I agree with you, as does this man, who lays it out quite succintly.

http://www.youtube.com/watch?v=0QyvgnswrtQ 

Tue, 06/03/2014 - 10:48 | 4820033 dontgoforit
dontgoforit's picture

The man has a point; however, there are no guarantees - we all have to make the effort, work the work, pull the sled, fight the good fight.  It may be the myth of Sysyphus, but it's our destiny.  "What else can you do?" he asks.  That's it.  We gotta make the attempt.  It can be a tough world.  We have to keep working at it.

Tue, 06/03/2014 - 09:39 | 4819849 Winston Churchill
Winston Churchill's picture

All well and good if you're not the GRC.

Mr Yellen will be free to do all that, sooner than you think.

The best current estimate for the BRIICS to have all required infrastructure in place to

depose king dollar is December.

Its pretty obvious by now that they are are not going to join a SDR and SDRM system, and

are going their own way. Only WWIII is going to stop them at this point.

I love the way they led the west up the garden path for years.

Tue, 06/03/2014 - 10:41 | 4819999 viahj
viahj's picture

i'm not entirely sure of that.  if the BRICs do go outside of the SDR/BIS/IMF there certainly will be war, a devastaing one.  do they want that?  maybe but i doubt it.  they would be better off taking the lion's share of the SDR rebalancing (rebalanced with gold backing, hence the insatiable appetite for gold by the BRICs).  by remainging in the current system they just take control over it with the USD/EURO/YEN taking a hit in the basket ratios.  lord knows that the oligarchy would want the ability to seamlessly move into a new global system as well.  if we burn Europe/USA to the ground, that ain't happening. 

Tue, 06/03/2014 - 11:10 | 4820106 Winston Churchill
Winston Churchill's picture

Unless a SDR system effectively devastates the US military budgets its not going to happen.

For  exactly that reason its not happening peacefully.

The Oligarchs are far from a homogeous group, whatever many here think.

Sure the western oligarch want to slip seamlessly into a SDR regime.

The eastern ones see no reason now to for a bankrupt west to have any seat at the table.

It may be the compromise solution, after much blood has flowed.

Tue, 06/03/2014 - 11:25 | 4820148 813kml
813kml's picture

Excellent point, but even more concerning than funding the US siege machine is unrest on the homefront.  Any more disturbance to Western economies will certainly lead to citizens marching in the streets in the US and Europe.

The FED pulled out all the stops to keep Western economies inflated rather than taking its medicine in 2008, the desperation is palpable.

Tue, 06/03/2014 - 10:24 | 4819944 rum_runner
rum_runner's picture

The overarching narrative you're describing is one where people believe the Fed can do whatever it takes to keep the party going.  That narrative will fail at some point.  Thinking will shift from "the Fed's got my back" to "the Fed's full of shit and don't know what they're doing."  

When the market next gets spooked and Mr. Yellen gives some new un-taper measure there will be a pregnant pause while the market decides to either calm down because it got its sippy cup of gin'n juice back or it screws its face up and goes FUCK YOU and starts throwing things around.

Saying things like "the Fed will not allow" is to imbue them with powers they don't have.  They are simply converting what remains of one thing (faith in the buck) into another (tides of liquidity).  When that action fails to yield any net gain then their relevance is essentially over.

Tue, 06/03/2014 - 11:48 | 4820226 Overfed
Overfed's picture

Good points, except there is no one out there to prop up and backstop the US should hyperinflation or collateral collapse hit us. There likely wouldn't be a US any more.

Tue, 06/03/2014 - 09:08 | 4819766 Sudden Debt
Sudden Debt's picture

like clockwork... motherF....

Tue, 06/03/2014 - 09:22 | 4819804 Oldwood
Oldwood's picture

So, is selling one's kidney a taxable event? Moar profits?

Tue, 06/03/2014 - 09:25 | 4819814 THX 1178
THX 1178's picture

Eventually "They" will lose the ability to make that happen.

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