Guest Post: About Those Permanently Rising Corporate Profits...

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

About Those Permanently Rising Corporate Profits...

We're constantly assured stocks can't go down because corporate profits are rising. So what happens when they start falling as global recession takes hold and the U.S. dollar stops falling?

The entire "story" of the Bull market is stocks rests on one reed: permanently rising corporate profits. Too bad those profits are set to fall. Like everything else about the "recovery," the "rising corporate profits" story is founded on financial flim-flam, starting with the boost provided by a sinking dollar.

A simple example reveals how a declining dollar has grossly inflated U.S. global corporate profits. Let's say Johnson & Johnson made a 1 euro profit from a sale of toothpaste in Europe in 2003. Translated into U.S. dollars for its financial reports, that 1 euro became $1, as the euro and dollar were at parity.

Now when J&J earn that same 1 euro in profit, it translates into $1.40 in profit. The revenue remained the same, and the profit remained the same, but profits stated in dollars rose 40%.

And this effect isn't limited to Europe. Global Corporate America's profits made in China have risen 20% over the past few years when stated in U.S. dollars (USD) as the yuan has strengthened from 8 to the USD to 6.4 to the dollar.

To truly grasp the monumental scope of this smoke-and-mirrors game of "profits" rising from currency arbitrage, we have to recall that most of the big U.S. global corporations earn between 50% and 65% of their profits overseas. Since the dollar has weakened about 30% in the Fed's free-money campaign (quantitative easing), then we can guesstimate that fully 15% of all profits from global corporations is phantom: if half their profits are earned overseas, and the dollar declined 30%, then their overseas profits rose by 30%. Since that is half of all profit, then that 30% rise boosts total profits by 15%.

This gaming of corporate profits via weakening the dollar has long been a favorite Fed pastime:

Notice how the long slide in the dollar coincides with the Bull market 2002-08:

As noted on the chart, the game has been disrupted recently as global financial turmoil has led to the dollar slowly rising. Most commentators see the dollar as losing its "safe haven" standing, but safe haven has little to do with demand for dollars: it's much more a matter of needing dollars to pay down debt that is denominated in dollars.

As global financial crisis triggers margin calls and counterparty settlements in dollars, the demand for dollars rise. That's why the dollar spiked during the 2008 meltdown.

Now there is a second factor driving the dollar higher: the slow but sure demise of the euro. European authorities are rather naturally doing their best to slow the collapse, but their efforts will fail for the all the fundamental reasons I have covered here at length, for example Why the Eurozone and the Euro Are Both Doomed (June 23, 2011).

Since the euro is 60% of the dollar index (DXY), then the euro and the USD are on a see-saw: if the euro declines, the dollar must rise, and vice versa. The euro's current valuation looks extremely high in terms of standard deviation:

Notice how non-financial (i.e. global) corporate profits spiked up from 2002:

Here we see just how outsized corporate profits have become in historical terms:

What happens to corporate profits if the dollar stops declining? They take a huge hit, that's what.

The second reason why corporate profits have soared is labor costs have been slashed via layoffs, early retirement and the wholesale movement to contract/free-lance workforce. Put another way, labor's share of corporate revenues has plummeted, a fact reflected in this chart:

While mass layoffs may be declining, that doesn't mean Corporate America is hiring domestically. Rather, the slash-and-burn campaign to lower labor costs to boost profits continues with undimmed ferocity, as those of you within the gurgling bowels of Corporate America know all too well.

The third factor is the global recession. While headlines this morning are cheering a blip up in retail sales in America as "proof the recovery is intact," the majority of other data from the nation and around the globe indicate a slowing global economy. Corporate America has squeezed vast profits from slashing costs and the weak dollar, but it's reached the point where no more big profits can be reaped from those factors. If revenue slips, so will profits.

A fourth factor is the flow of government largesse will no longer be expanding. Corporations have been reaping guaranteed profits from government spending (not hiring people, just skimming profits), and now that the fiscal flood is facing some constraints, that trillion-dollar prop under Corporate America is weakening.

The easy money's been made from slashing costs and dollar arbitrage; all four supports of corporate profits are at risk. With these props gone, how are corporate profits going to keep rising? If the "rising corporate profits" story dissipates, so does the Bull market.

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buzzsaw99's picture

as if profits have anything to do with stock prices. equities go up when losses are less than expected, or because a pigeon is cooing outside some hedge fund trader's window, or because bernanke belched at a meeting. profits, we don't need no steenking profits!

TheGameIsRigged's picture

Amazing info.....You would NEVER see this on Bubblevision.  TPTB would not let this info get out....and even if it did, most people are too preoccupied to even notice.

Thanks, Tyler

TruthInSunshine's picture

Tyler, don't forget to let everyone know that along with those "record profits", publicly traded corporations have issued a record 12 trillion in debt via the selling of bonds, taking advantage of the suppression in yields on government bonds, which are their main competition (so if gov't bond yields go lower, so do corporate bond yields - e,g. IBM selling a three year, multibillion dollar bond which yields 1%).

Publicly traded corporations have more debt now than ever.


pazmaker's picture

but....CNBC keeps on saying Corporations have cash surpluses because they are sitting on so much cash!   hahaha!

TruthInSunshine's picture

Some say that it was responsible for the death of financial markets and the slaughter of whatever had formerly remained of journalism that was in any degree, no matter how miniscule, fact-based...

...all we know is that it's called CNBC.

Popo's picture

(Thank Charles Hugh Smith.  Of Two Minds is one of the best blogs on the web, imho)

tj3's picture

Thanks Tyler, Thanks Mr. C.H. Smith

"Although the euro was supposed to create efficiencies by removing the costs of multiple currencies, it has had a subtly pernicious disregard for the underlying efficiencies of each eurozone economy."

SheepDog-One's picture

Good article...its freakin hopeless. Even vast new money printing wont work now, the dollar crush effect has already been maxed out.

Whats next? As stocks resume their brisk and chipper march steadily upwards.

Boilermaker's picture

Up, down, around.  What fucking difference does it make?  You're either running the game or getting gamed.  I know I'm part of the latter.  So, I couldn't give a shit less what they do with the markets now.  They're dead to me.

SheepDog-One's picture

All just a setup now to transfer as much wealth as possible from the peasantry to the banksters, every last bit of it. They already got the home value robbed, now for the 401K and pension robbery. I dont know what the next phase of the of the operation '3rd world america' will look like but probably big market plunge and lots of hysteria, get people to sell out at the bottom, while the banks use the next QE to buy it all up and 'annuitize' everyones holdings. Total control, bitchez.

baby_BLYTHE's picture

you would think they would use those 'heaps of cash' to buy up infrastructure, land, tools and hire more workers, instead they have decided they would rather hold a rapidly depreciating currency, bite their lip and hope the economy miraculously recovers.

Honestly all these pumped asset values and record profits are just the QEs (printed money) that made its way onto their balance sheets while the average American didn't get shit.

I hate the principle of money printing, but we no doubt would be in much better shape if we simply printed up the 1.6 trillion and divided it up and distributed it to ever man, woman and child that draws oxygen on American soil. That way they could have delivered more meaningfully, cleansed their balance sheets, saved some of the money and spent some of the rest directly into the economy.

Obviously, the Constitution doesn't matter. If it did, under the language of "All created equal" every American would have access to the FED discount window and be able to borrow at .25 bps to invest in higher yielding assets.

SheepDog-One's picture

Thats what I was arguing to do ever since '08...if you insist on printing money to stimulate things then divide it up and send it to the people. Nah cant have that, better to give trillions to a few select bankers and CEO's. So now our only option is far more of the same, until we all gag and choke to death on it.

baby_BLYTHE's picture

so women aren't allowed into Fight Club, eh?

I am probably one of the only, if not the only, ZHer that has been to an actual Fight Club. As a spectator of course, watched my cousin kick some punk ass in the steel cage.

Oh regional Indian's picture

bB, there has been a noicable change in your tone and apparent eruditeness since you turned 21. Your commentary has taken on a totally different tone/hue.

Making some suspect you are not who you say you are.


baby_BLYTHE's picture

considering leaving ZH anyway, the quality of comments since spring 20010 has changed considerably. The Tylers are great, of course. I don't plan to ever stop reading their commentaries on economic news.

I could give a shit less if people think I am a fraud. I say to them, 'go eat a shotgun shell' you aren't worth the space on this planet anyhow.

This is a waste of everyone's time and detracts from what should be deep meaningful discussions. I am here to debate and engage with other ZHers.

ElvisDog's picture

Hey baby_BLYTHE, I've developed a comment filter. Whenever I see words like "zionist", "new world order", and such I know it's probably time to bail on the comments for that post. I agree that there are a lot more crap comments as a percentage these days but there are still gems out there if you are patient.

disabledvet's picture

I apologize for questioning your manly intelligence! YOU WIN! YOU WIN! I have no clue about "fight club" because whenever i fought i cheated and killed the guy first.

Kynortas's picture

Previous Corporate Finance research showed that management is less likely to invest in projects when interest rates are low.

Firstly, all projects delivered a positive NPV in a low interest rate world.

Secondly, management persisted with high qualifying hurdle rates e.g 15%. Maintaining this high hurdle rate stopped management from moving forward on any projects!

slaughterer's picture

My new user icon says: "brisk and chipper"?

Pay Day Today's picture

I'm suddenly more upbeat on the economy than I was a second ago.

onlooker's picture

Plentiful and cheap coal in China coupled with no EPA is also a factor. Tax friendly nations that have stolen USA industry is another issue not yet addressed, except by Texas.

V in PA's picture

+1. Regulations and taxes are what killed America's manufacturing base. Not wages.

SMG's picture

Partly, but the real destroyer of the base are the unlimited free trade agreements.  Until we adopt a US national interest trade policy.

That combined with lower taxes and more reasonable regulations would improve all of our lives.



disabledvet's picture

We lost WW 2. That's why mfg got annihilated.

V in PA's picture

I would like to read about the 'lost WW2' theory. Please provide a link. Thanks.

Oh regional Indian's picture

Google operation paperclip.

follow that trail.


disabledvet's picture

That's easy. 1950 CEO says to Congress in Congress: "what's good for GM is good for America." 2009: Congress says to Pontiac and Saturn: "no it's not." move along...move along.

apberusdisvet's picture

As a friend of many small business entrepreneurs, I have been aware of the creeping margin compression for some months now.  The Q2 earning reports of listed companies are probably the last time that cooked books can paper over the problems.  Q3 will produce an epiphany; no place to run; potentially enormous selloff.

Crack-up Boom's picture

Months?  Maybe your friends didn't talk about it at first, but the margin compression started in 2008.  Small businesses have been in crisis mode for three years.  They've already trimmed the fat and some of the muscle.  What's left (to mix metaphors) is a tight ship that still might not weather the storm.

Boilermaker's picture

Why would the fact that profits are going to fall affect what's left of this pathetic fraudfest of a market?  Clearly, the game is to be on the right side of the 'action' prior to the lift-off or collapse.

It's nothing but a fleecing mechanism for the non-connected.  Period.

Internet Tough Guy's picture

Uh, the euro isn't collapsing against the dollar, and it isn't going anywhere.

SheepDog-One's picture

Nothings really going anywhere, currencies just trade a small blip up or down but remain about the same, stocks even for all the wild gyrations are where they were just weeks ago. And on top of all the totaly calm markets, The Bernank will supposedly make the dire case argument for massive further QE? Im still waiting for anyone to explain exactly how that happens at all.

What if everyone is wrong and there is no QE at all and Ben just says 'we'll wait and see', as he's said recently? Remember the big FOMC let-down statement only days ago? This is all insane, good luck people youll need it.

TruthInSunshine's picture

Uh, the euro isn't collapsing against the dollar, and it isn't going anywhere.


Right, because the EU will not have to print many, many trillions via the ECB to save the indebted (France, Italy, Spain, Portugal, Ireland, Greece...who'd I leave off?) member states, let alone the banks HQ'd in EU Member States, and because everyone, including Germans, are so enamored with the EU that they'll bleed out financially for the great welfare state experiment.


Crack-up Boom's picture

(France, Italy, Spain, Portugal, Ireland, Greece...who'd I leave off?)

It used to be the PIIGS.  Now it's the "F"ing PIIGS! 

TruthInSunshine's picture

Nice! I was looking for a new Acronym.

As a bonus, yours has a what will soon be a very sickly company, ING, in it!

All is well that ends well, or so some say!

I'm doubling down on my short of The Bernank & The Trichet. I thought I'd sooner see PIIGS fly than Germans, French, Italians & Brits work anything out, over anything resembling a long horizon.

Pip, pip, cheerio.

disabledvet's picture

I agree. That' the round peg in the square hole here. DM is growing 5 pct with nmbr 2 Japan in deep doo doo. EU is toast tho. What do the French say? (such BEAUTIFUL people!) After the deluge a flood.

TruthInSunshine's picture

We're all confirmation bias seeking humans, but your opinion definitely confirms my bias.

In a world of hideous currencies amongst developed, large nations (Yen excluded, which there's no rational explanation for), the EUR will soon have no ALIBI as one of the ugliest chicks in school.

disabledvet's picture

I was commenting while driving so excuse the hiatus and spelling errors. The Euro can become "the German euro" at any time and they represent ferocious competition for the USA. The surging yen terrifies me because it says the USA has serious competitive issues at the macro level. Somebody's come to "fight" in the economic sense and to me that ultimately will be good for Germany, Japan and the USA. Doing so in something other than a "zero-sum" way however will be a real challenge for policy makers in all these governments.

ben_bernanke's picture

Seriously, is this blog written by someone in Goldman Sachs? Why does the market generally do the opposite of everything implied by the posts?

fuu's picture

Goddamit Ben wtf are you reading ZH right now? Get back to the presses so we can stay in skittles and rainbows forever.

tj3's picture

It has to do more with time-horzions then anything-else. Hours, Days, Weeks, Months, Years, Decades. Your perception of how this thing of ours the market generally does the opposite of everything implied by the posts?

You know how true believers never look at the solid Blue chip stocks they own? Or the gold bugs for that matter. I think Tyler at his best, focuses on that long term view.

tldr, ymmv

web bot's picture

I'm really starting to like Charles Hugh Smith's writings.

Keep posting them. 

linrom's picture

Only a few per year, the rest are merely restatements pf positions taken on by the Peterson Institute.

ThirdCoastSurfer's picture

Nice! Especially the toothpaste example. 

Add government overspending, 2 wars, cap-ex & FICA tax breaks & zero Fed lending, and you see that the US has more crutches than Spiderman's nemesis Doctor Octopus. 

Then there the just the outrageous statements. To listen to Caterpillar's CEO Doug Oberhelman rattle on about hiring thousands and thousands of employees every month without detailing that some people actually leave or retire and thus need to be replaced is beyond bizarre and in itself is worthy of Spiderman's other nemesis "After Dark".