Why Profits Are Faltering

Tyler Durden's picture

Submitted by Charles Hugh-Smith via OfTwoMinds blog,

Profits are faltering for structural reasons that are not easily resolved..

The bedrock assumption of the Bull market is that corporate profits will keep rising indefinitely. Hiccups are allowed, but current stock market valuations are implicitly based on profits expanding.

The fly in the ointment here is corporate profits have been stagnating since 2014. Here is the St. Louis Federal Reserve (FRED) chart of pre-tax corporate profits:

Is it just coincidence that profits have stagnated since the U.S. dollar strengthened in early 2014? Actually, there is a causal connection between the USD and corporate profits.

The majority of America's large corporations are global, and up to half of their sales and profits are earned overseas in other currencies.

Consider the impact of foreign exchange fluctuations on profits when converted to dollars. When the euro and the dollar were 1-to-1 back in the early 2000s, 100 euros of profit earned by U.S. corporations in Europe converted to $100 when stated in dollars.

When the euro strengthened to $1.40 (and the USD weakened accordingly), the same 100 euros of profit earned by the U.S. corporation in Europe converted to a $140 in profit when stated in dollars--a hefty 40% premium gained entirely as a result of the weak dollar.

So profits earned in euros soared 40%, not from rising sales or fatter margins, but as the direct result of a weak USD. Now the trend has reversed, and as I have been discussing for years, the USD is in a multi-year uptrend.

Which brings us to this FRED chart of the trade-weighted (broad) U.S. dollar index. Is it just coincidence that a strong dollar is correlated to recessions?

Given that profits earned in other currencies crumble when the dollar soars, it follows that there is a profits recession in strong-dollar eras, and that pressure on profits may contribute to an economy-wide slippage.

But profits are faltering for domestic reasons as well. The cost pressures crushing the restaurant sector (There's A Massive Restaurant Bubble, And It's About To Burst) are not limited to restaurants: rents are soaring for households, crimping disposable income, while small businesses across many sectors are facing rent increases.

Then there's healthcare. I have noted many times over the years that healthcare can and will bankrupt the nation: for example, How Healthcare Is Dooming the U.S. Economy and Can Chronic Ill-Health Bring Down Great Nations? Yes It Can, Yes It Will.

The restaurant described in the above article saw its healthcare costs for employees skyrocket from $14,000 to $86,000 in a few years. While this may seem extreme to those of you who are not exposed to the real, unsubsidized cost of U.S. healthcare, those of us who pay real, unsubsidized costs are not surprised at all.

Every dollar diverted to healthcare and pharma cartels is a dollar that is unavailable to the enterprise or employee for other spending or investment. As I have noted, skyrocketing healthcare costs act as an economy-wide tax.

Then there's rising wages. Most people view increases in minimum wages sympathetically, and there are solid arguments in favor of returning the minimum wage to its purchasing power in 1970.

But to enterprises staggering under higher rents, higher healthcare costs and higher junk fees/local taxes, increased wages may be the coup de grace.

In sum: profits are faltering for structural reasons that are not easily resolved.

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JRobby's picture

Are we talking about GAAP or Non-GAAP profits?

Because GAAP profits are flat to declining back to 2011 levels for the S&P 500.


philipat's picture

Great observation and, yes, on a GAAP basis the earnings for instance of the S&P have declined to about $80 for a P/E of around 26X, very high especially given the precarious state of the real global economy. GAAP earnings are the only true measure of value and they are also referred to as "As REPORTED" for the good reason that these are the actual earnings reported fro statutory purposes.

The data reported in the article is just the aggregate of all Corporate earnings fro all US Corps, public and private and such a broad brush picture doesn't really help much for analysis of valuation. That said, it is surprising to note such a recovery in the last sevral years on this basis so I suspect that it can't be on a GAAP basis?

LowerSlowerDelaware_LSD's picture
LowerSlowerDelaware_LSD (not verified) philipat Jan 5, 2017 8:54 PM

Plus part time jobs won't buy as much as full time. But the gubmint still counts them the same.

1980XLS's picture

Tax cuts will more than offset the slump in profits.


svs9000's picture

DOW 20,000 any day/week/month/year now....

billwilson2's picture

Perfect timing. Donald tRump, welcome to the real world. All your huffing and puffing and lying can not make america great again. The die is cast, you just walked into a brick wall.

illuminatus's picture

Who needs stinkin profits when central banks are buying stocks?

hooligan2009's picture

the TW USD is coincidental to the levelof profits since multinationals dont declare overseas profits in the US anyway.

the question is: how much has the the S&P priced in the increase in NET OF US TAX earnings from the change in the headline US corporate tax rate - that may drop from 35% to 20%.

the impact on NET EARNINGS of the drop in the tax rate is an increase in NET EARNINGS of 23%.


gross earnings of 100 dollars taxed at 35% = 65 dollars of NET earnings

gross earnings of 100 dollars taxed at 20% = 80 dollars of NET earnings

increase in NET earnings = 80/65 = +23%

the market is probability adjusting the timing and size of the increase in NET earnings.

konadog's picture

When your business plan consists of laying off 20% of the employees every year until the last person says home on Thursday, borrowing elephantine amounts of money to buy back stock, and outsourcing customer facing functions to a bunch of lazy idiots in 3rd world countries, WTF do you expect?  For this, we're paying these geniuses $100M bonuses.


When I dismantled the Western Empire, & the Global Banking Oligopoly, I fully intended on taking down the entire worldwide corporate structure, & architecture, that undergirds it. One cannot take down only a subsystem of the superstructure and expect a worldwide global banking implosion. One must be all encompassing in scope not unlike the Deep State tactically. Moreover, I, for one, am still amazed at how the Corporate world can levitate in the midst of wholesale bankruptcy across the board of the Corporate world, and especially in America. Clearly, some drug money must be propping more than a few blue chip corporations up for photo OPS of late.

HokumYTrader's picture
HokumYTrader (not verified) Jan 5, 2017 8:32 PM

Every year the "analyst" put S&P 500 earnings at somewhere between 130 and 140 at the start of the year (they will quietly lower those forecasts over the course of the year), this year they are all adding 10 for the Trump factor multiply by 18 or 19 and you can claim a 7 to 10 percent forecast. It is bullshit, but what on Wall Street isn't. It is not about the numbers it is about the narrative.

south40_dreams's picture

Some rocks are so dry there's no blood left in them to squeeze out