No Record Profits For Old Assets: Jim Montier On Unsustainable Parabolic Margin Expansion For Dummies

Tyler Durden's picture

It is widely known that US corporate profits recently hit an all time high. What is less known is that in Q4, profit margins for the first time rolled over by 27 bps, and double that if one excludes Apple. What is very much irrelevant, is that to Wall Street none of this matters, and the consensus (of which GMO's Jim Montier says "the Wall Street consensus has a pretty good record of being completely and utterly wrong") believes that Q4 will be largely ignored, and margins will continue soaring ever higher. Well, the same Montier, has a thing or two to say about this consensus surge in profits ("it is almost unthinkable that it will remain at current levels over the course of the next few years"). More importantly he looks at the Kalecki profits equation, and finds something rather peculiar. Namely Japan. Because while taking the profits equation at its face value would surely explain the 10.2% in corporate profits, of which a whopping 75% is thanks to America's burgeoning deficit, it would imply that Japanese corporate profitability, where there has been not only a long-running current account surplus, but zero household savings, and massive fiscal deficits, should be off the charts. Instead it is collapsing. Why? Montier has some ideas which may force Wall Street to renounce its bullish views, although probably won't. However, the implications of his conclusion are far more substantial, and if appreciated by corporate America (whose aging asset base is the problem), may ultimately result in a revitalization of the corporate asset base, however not before the dividend chasing frenzy pops in the latest and greatest bubble collapse.

First of all, for those who are not familiar with Kaleci, the Profits Equation, or any form of generic mumbo jumbo, here is the equation in question:

Profits = Investment – Household Savings – Government Savings – Foreign Savings + Dividends

How has this equation resulted in record profits? The chart below breaks out the various components:

Breaking this down historically yields the following chart:

So looking at historical and projected profit earnings, this is the consensus. Bear in mind this is critical for year end S&P targets above last year's closing level to make any sense without multiple expansion.

On the surface, this could be explained using the profits equation:

Let’s briefly examine the logic behind these drivers of profits. Investment (technically, investment net of depreciation) drives profits because when a firm or a household decides to invest in some real asset they are effectively buying the good from another firm, creating profits for that entity. Remember that this is aggregate; any single firm (even the world’s largest) is minuscule relative to the total amount of investment that occurs, so it isn’t possible for any given firm to bootstrap itself into profitability via investment.

Household savings are a drag on profits. This should be fairly obvious. Wages are paid by corporates to households, forming income from the household perspective. If some of this is saved, it is clearly not recycled into spending and, hence, is lost from the corporates’ year-by-year profits point of view.


Just like the household sector, government sector savings are a drag on profits. There are many transmission mechanisms between the government sector and the business sector, some reducing profits, some increasing profits. There is the tax route, whereby personal income tax reduces the amount of profits available to the business sector. Conversely, the government is also an employer, paying its employees who in turn spend and create profits. Plus, of course, there is direct interaction between the government sector and the business sector when the government is buying goods and services. All of these interactions (plus others) can be summarized into the government sector savings.


Foreign savings (also known as the current account balance) are also a drag on profits. Remember that the current account balance measures the amount that the U.S. owes to the rest of world (in terms of both actual goods and services purchased and investment flows) minus the amount that the rest of the world owes to the U.S. (again in terms of payments for goods and services and investment flows). If the U.S. is running a current account deficit, then it owes the rest of the world, and this is lost potential profits from the perspective of the domestic business sector.


Finally, we have dividends. This may seem like a counterintuitive source of profits since these are paid out by the business sector to households. However, from the perspective of the household sector, these are a form of income, which can be spent, thereby creating profits for the business sector.

This is all great. There is however one problem. Japan.

In Japan, we find a situation where the household sector is saving very little, there is a current account surplus, and the government is running a massive fiscal deficit. On these grounds, one would expect Japanese profit margins to be soaring. However, this

isn’t what we find. As Exhibit 7 shows, Japanese profit margins have been far below those seen in other nations. 

What is the explanation for this dramatic outlier?

Given the massive tailwinds listed above, this can really only imply that net investment must have been massively negative - effectively, depreciation has outstripped any new investment. One can only ponder just how appalling Japanese profit margins would have been without all of the government help over the last two decades! Of course, if net investment were to turn positive (or even stop being quite so negative), then Japan could witness a marked improvement in margins.

And so once again we get back to what we have dubbed the primary cause of all of modern capitalism's problems: a dilapidated, aging, increasingly less cash flow generating asset base! Because absent massive Capital Expenditure reinvestment, the existing asset base has been amortized to the point of no return, and beyond. The problem is that as David Rosenberg pointed out earlier, companies are now forced to spend the bulk of their cash on dividend payouts, courtesy of ZIRP which has collapsed interest income. Which means far less cash left for SG&A, i.e., hiring workers, as temp workers is the best that the current "recovering" economy apparently can do. It also means far, far less cash for CapEx spending. Which ultimately means a plunging profit margin due to decrepit assets no longer performing at their peak levels, and in many cases far worse.

Furthermore, recall that in February we penned: '"No Continent For Young Assets" - Charting The Root Of Europe's Problems: Record Old Asset Age' in which we observed that the average age of European assets has hit a record high.

This also explains why banks have to dig progressively deeper into the sewer to pull out virtually anything that floats and hand it off to the ECB for collateralization, either in the open system or via repo. The reason is simple - there are not enough normal assets! And while we do not have the primary data, we are willing to wager that the average US asset's age is well on its way to record decrepitation.

The conclusion of all this is quite simple: the longer the "recovery" continues, without an actual recovery being coincident, and all is merely a game of optics and smoke and mirrors, corporate margins will start collapsing in a toxic spiral, whereby companies generate less cash, and have less cash to spend on CapEx, etc, until the next sector needing a Fed bailout is the corporate one, all the while the Fed's forced misallocation of resources forces companies to expend every available penny into dividend payouts.

Of course, this may well change. But if it does, and instead of pumping dividends, corporations do what they should be doing, which is begin the long overdue overhaul and update of their asset base, thing will eventually get back to normal, however record profit corporate margins will take a long time to return. And in the meantime, we sure would not want to be on the offer side of the collapsing dividend bubble...


Full Montier paper can be found here.

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The trend is your friend's picture

Margin Compression bitchez

Unprepared's picture

I stopped believing in any formula that does not factor in debt or assumes leverage is extinguishable at any time.

Profit = Debt + Inv. - S - G - X + D

Unprepared's picture

Oh, and ... Asset dilution, bitchez

derek_vineyard's picture

tax dividends as ordinary income as is normal

Ropingdown's picture

Taxing dividends as ordinary income is not normal, even in high-tax countries such as Sweden.  Taxing fund-manager bonuses as ordinary income (not carried-interest) is not normal.

The Big Ching-aso's picture



I'm divided about dividends.   I kinda feel like they're a stealth BS substitute for what should be real stock appreciation.

Popo's picture

Exactly the opposite is the case.  The notion that the stock should appreciate constantly is mathematically absurd.   Once upon a time in America *all* stocks paid dividends.  The more modern notion of ponzi style appreciation of equity value is based on bubblenomics and puts hype over substance.

A dividend represents a mathematical "share" of company profits.     By contrast (as everyone knows) there is often very little justification for the relationship between share-price and underlying value.     A dividend is mathematically/financially supportable.    Share price often isn't.

BigJim's picture

It seems to me you're both right.

In an elastic monetary system, you'd expect stock price indices' movements to at least bear some resemblance to money supply.

So, while M3/M4 were expanding, it was reasonable to assume stock prices would, too.

The Big Ching-aso's picture



Ya, what I was driving at.    I guess I stand uncorrected.

Mario55's picture

Taxing dividends as ordinary income is like double taxation. Taxes should be thought of as a take on the created wealth, not a take on what comes into one's pocket, whatever the source. Otherwise you end up with a confiscating dinosaur state. 

TruthInSunshine's picture

Sell-Siders all over babbling about record corporate profits, and nary a peep about near-record (and possibly beyond record, by now) debt:


Robust Corporate Bond Issuance Is Approaching Weekly Record

And it was near 2 trillion of corporate debt back in 2011, so who knows how much higher that figure is as of now -

Law of Unintended Consequences: Corporate Borrowing Binge

So far in 2011, syndicated loan volume has increased a whopping 56% compared to 2010, according to Dealogic. The total of $1.76 trillion is the highest single-year sum since the pre-financial crisis days of 2007...



This is yet another unintended consequence of zero percent rates.  Investment grade companies increasing their borrowing by 68% year over year has certainly not led to hiring.  Maybe we can just say that perhaps it stalls the pace of further layoffs, we seem to have gotten good at merely accepting "saved jobs" these days anyhow.


And so the Balance Sheet Recession continues apace for the deleveraging consumer while those with the greatest ability to borrow (and, god forbid, spend) continue to pad their balance sheets with fresh cash.  That they have no need for.

Nicely done.


Here's the problem the sell-siders and even many innocent observers never mention or don't understand:

This 2 trillion plus (by now, since the 1.8 trillion figure was back in 2011) of 'borrowing' IS NOT CASH. It's debt that has to be rolled over or repaid.

lizzy36's picture

Sell side only works when markets are going up.

Don't expect them to do anything but talk their book.

TruthInSunshine's picture

Not only that, but their enablers in the financial media haven't even bothered to do their journalistic duty, as an essential pillar of our democracy /sarc, to raise questions as to why "profit churning machines" feel to the need to be "debt borrowing machines."

Carl Spackler's picture

Not only that, but their enablers in the financial media haven't even bothered to do their journalistic duty, as an essential pillar of our democracy /sarc, to raise questions as to why "profit churning machines" feel to the need to be "debt borrowing machines."

Their enablers will proffer the excuse that they are actually in the business of providing financial "news" as entertainment.

poor fella's picture

"It's debt that has to be rolled over or repaid."  <-- that, could be debatable

buchesky's picture

The calculation does take debt into account. It's a component of government savings, which is negative in this case. This is the more staggering observation from this chart--our government must continue to run a massive deficit in order to maintain these high corporate profits. Sell side analysts think that rising yields on treasuries mean money will be diverted from bonds to stocks, but rising yields really mean the U.S. government will not be able to borrow as much, hence declining corporate profits.

beenburnedtwice's picture

Mr. Mon-Tee-Ay (with an r),

Coming oil price hikes will crash, and trump, all other analysis, just like 2007.  Wash, rinse, and three-peat.

fonzannoon's picture

I don't know. Even CNBCrap was acknowledging that this earnings season was going to suck. But the key is it is an anomoly. Yup.


Cursive's picture

Another Keynesian metric....

xtop23's picture

God, if only the damn weather would cooperate this could go on forever.

Damn you Mother Nature !

djsmps's picture

As long as Malia is OK after that nasty Iran-caused earthquake.

Alea Iactaest's picture

I thought it was the Russians. You know, kind of a warning shot like that EMP by the Chinese off San Diego (stranded that cruise ship and all).

kridkrid's picture

Wasn't there some sort of missile fired a couple of years ao as well (off the coast of California)? I think the official explanation was a plane providing some sort of optical illusion.

LetThemEatRand's picture

This is all about the oligarchs raping the productive middle class.   They bonus themselves into elite oblivion with fine Fed powder while the little people wake up with the hangover.  

LongSoupLine's picture

The 3rd chart's dotted line looks like it was drawn by Lazlo Birinyi

HD's picture

Not to derail the thread - but it looks like we can longer track our old posts...why is this?

pavman's picture

Weird.  Try doing a search on your name (albeit, your name might show up more frequently than others).  I know I have more than 1 lousy post... wth!  Hopefully ZH is trying to protect us from big sis and hasn't sold out....

And why does it say 'new' next to my name... am I new, or is the post new?!  wth! 

HD's picture

Seems to be fixed now. Thanks.

MeelionDollerBogus's picture

The search method has changed.

I no longer see notifications indicating new replies to a previous article I replied to. What I can see are new comments (n/a about replies) from a particular person, including myself

this link for my comments

this link for our FAVORITE commenter

and this one for our photoshopping fav

Postal's picture

Wait, so if businesses made *gasp* investments--sound, planned, actual--investments in their infrastructure, personnel, other capital instead of short-sighed "grab-the-cash-and-run" business models, then (well employed) consumers could actually stimulate growth? [sarc] Now why would anybody do that? Don't you know that heli-Ben can just print 'money' and the banks can give it to all ready over-leveraged consumers on plastic cards? Now why does that require any form of "investment" (which equals risk to the investor), planning, or responsibility? [/sarc]

Lady Heather...UNCLE's picture

...reduced margins equal pressure on stocks=QE(=bullish)=greater margin compression thru inflation=more QE=bullish=( Repeat as needed)...= zero profitability= all your stocks belong to us so who cares> Now for a reset on that debased currency. Not our fault, NOONE could see this coming.

aphlaque_duck's picture

OT - any opinions on Euro Pacific Capital (managed account)? I already have my silver, 5 acres, and a well diversified portfolio of vegetables. thanks

oldman's picture


I'm sorry but what does what you have, have to do with thisa article

Don't you have a twitter account for that stuff?

Respectfully               om

aphlaque_duck's picture

I assumed many people here are familiar with Peter Schiff's company and thought someone might have some thoughts. I'm an asshole for being completely offtopic, but the 'OT' excuses it. That's the rules I believe. 

OT: I can answer any questions you may have about supplemental insurance.

I am a Man I am Forty's picture

don't mind the board nazi's, oldman doesn't dictate what the fuck u write or anyone else, i like peter schiff but euro pac didn't do very well in the crisis which is surprising since he saw it coming, he was very bearish on the US (correctly so) but very bullish on european dividend stocks so he got creamed like everyone else, there were several people i remember complaining that they had money with him and lost 40% plus during the crisis, i read a couple of his books while all this was going on and he was right about gold and silver and not much about anything else, once again i am a fan but I wouldn't invest with him.

Also his idiot brother had a stupid piece in bloomberg  recently, considering he is in charge of marketing, pretty stupid.

People go OT all the time on this board, ever since i've been around.

aphlaque_duck's picture

EXACTLY my concern, thanks.

He says the next crisis may not be the same as '08, which I can believe. He will probably be right eventually but I think there is tremendous downside potential in the portfolio if global demand destruction occurs before (or concurrent with) USD collapse.

ebworthen's picture

No downside to acerage and vegetables.

Cash works for the time being, and PM's until you hear Roosevelt confiscation inklings from Obama or the next admin.

I wouldn't put more than 17% with any one person, fund, or category myself.

As cheap as natural gas is and as high as oil is that would be a long term play IMHO as ten years out it has to go up one way or another (heating, nitrogen production, etc. - and that is if they don't start running cars and trucks on it).

oldman's picture


Thanks for taking me off the hook. I was afraid no one would ever say a word and I'd be stuck with the Dictator role forever.

You and the Duck make it seem a bit more it was a year and half ago. Most of my heroes from those days are gone------

oldman,oldtimes,oldmemories          om                  









oldman's picture

Hey Duck,

You're a fun guy to play with----nice response

Thanks      om

GeezerGeek's picture

About that diversified portfolio of vegetables: did you not see the latest executive order from the Big O? "All your vegetables are belong to us, if we want." And look for a visit from Mayor BloomingIdiot to verify that your vegetables are of the politically acceptable variety.

Let The Wurlitzer Play's picture

The second paragraph sums this up "mumbo jumbo".

This is keynesian(socialist) non sense.  Th governmant savings should be positive, there should also be a exponetial factor related to the government savings because of the compounding effect governmnet funding has on the economy.  This leads me to one conclusion.  Kaleci was an idiot.


Harbanger's picture

Thanks for reminding people that modern Keynesian economics is a Socialist experiment. 

"Marx's work sharpened the existing differences between the revolutionary and non-revolutionary socialists.

Non-revolutionary socialists took inspiration from the work of Jon Stuart Mill , and later Keynes and the

Keynesians, who provided theoretical justification for (potentially very extensive) state involvement in an existing market economy]. According to the Keynesians, if the business cycle could be solved by national ownership of key industries and state direction of their investment, class antagonism would be effectively tamed; a compact would be formed between labour and the capitalists. There would be no need for revolution; instead Keynes looked to the eventual "euthenasia of the rentier" sometime in the far future….”

Dre4dwolf's picture

IF theres one thing I know its that paroblas are dangerous.

oldman's picture

Nice article.

I guess this point will be one of the key changes in the coming new machine. I don't understand how this will come about, but it is obviously a huge glitch in the old machine especially considering the limitations of  the real world vis-vis population growth sustainability and spreading the product of society in an equitable manner.

If I were younger or more interested in the human context, I would probably view this area well worth studying. There must be something 'organic' coming that no one sees because I never met any capitalists who want to spread the wealth or have a new idea about population growth sustainability; capitalists with such thoughts go by other names.

Well written and comprehensive piece, thanks               om

Sophist Economicus's picture

This is 'classical economics' mumbo-jumbo.    Corporate profits may ultimately fall, but the reasons above are not convincing -- there will be a bust that will swamp efforts of the best management teams in the short-run.    But short of a complete lack of demand for products for a LOOOOONG period of time, companies will their adjust the allocation of scarce resources in a way to make a profit.   


BTW, we've been waiting for 'record corporate earnings' to fall for a few years now....

Caviar Emptor's picture

It's like this: unless the financial world can stun us with unprecedented irrational exuberance the crisis atmosphere will live on for years. 

poor fella's picture

Along with the Pentacon's 'war on terror'

jonan's picture

is it bad that i've given up trying to find a job and just play the piano all day? i mean, that's the only thing i'll have left which has any value when the owl takes the last lick of the tootsipop...

anyway, half a year left before i get my degree in finance, which is going to be worthless when everyone realizes what type of finance the universities have been teaching (brainwashing) us with...i'm so fucked that i no longer care how fucked we collectively are...but hey gotta think positve right?

here's to a wonderfully bright future for my generation!!! /lollipop mode

diablo 3 comes out in may so i can play my sorrows away...maybe the ipad4 can run it?


BobPaulson's picture

Newsflash: GS clients toasted in special press conference.