Submitted by Joseph Carson, former Chief Economist & Director of Global Economic Research for Alliance Bernstein
Analysts and investors have been betting on a rebound in operating profits for 2020, even though profits are running up against a powerful (negative) trend in the annals of business cycles. New events on the international side of business will lower those odds even further.
Although Q4 2019 and full year operating profits have not been released in the GDP figures it is easy to derive a year-end and an annual figure based on the available data.
Operating profits for 2019 are estimated at $2,065 billion, off 0.5% from the prior year total, and extend the streak of annual declines in operating profits to 5, making it the longest stretch of consecutive annual declines in the post-period surpassing the prior record of 4 at the end of the 1990s.
Moreover, it’s hard to get optimistic about a rebound in operating profits anytime soon. The long history of business cycles show that unit profits and profits margins do not reverse a cyclical downtrend until there is a sustained reduction in operating costs (i.e. lower labor costs) that usually comes about at the end of the economic growth cycle---i.e. recession.
In the past 40 years there is only episode when unit profit and profit margins for nonfinancial companies made a meaningful mid-cycle upturn. That occurred in the mid-1980s following the plunge in the value of the dollar (e.g., declines of 30% to 40% against major currencies such as the Yen and Deutschmark) following the 1985 Plaza Accord.
Nothing comparable is on the horizon that will lift companies operating profits. In fact, international trends, which account for roughly 40 cents on every dollar of profit for US companies, are likely to squeeze earnings in the current year.
The crisis in China is creating havoc in global business. Without making any prediction about how long this crisis will persist there is one absolute truth about business - that is, when commerce is interrupted, slowed or idled completely company revenues and profits drop hard.
Analysts and investors have been viewing the developments in China as if business is merely deferred, not lost. That might be true for some of the businesses that deal with large-scale products, but for a number of businesses a large portion of sales are lost forever.
For example, a lot of regular business and leisure travel that has been postponed is probably lost, so too are the sales at a number of consumer-related companies - there is no pent up demand for a hotel room, a coffee or a burger. And no one is considering the loss of labor income - due to the idling of production lost travel as well as the complete closure of sales offices - on all sides of the ocean that could reduce consumer spending in current and coming quarters.
The list of companies that so far have indicated that Q1 business operations will be impacted cut across a number of industries. So far the list includes – Delta, American, United, GM, Ford, Tesla, Google, Starbucks, McDonalds, Boeing, Nike, Wynn Resorts, Hilton Hyatt and Marriott - and the list will undoubtedly grow in coming months.
Despite these warnings the equity markets have raced to new all time highs in early 2020. In some ways, the mindset of investors nowadays reminds me of the equity markets in early 2000.
Following the 85% gain in the NASDAQ composite index in 1999 and 20%+ gain in the S&P 500 investors felt nothing could go wrong, even though the fundamentals, operating profits, were deteriorating. In 1999, there were 12 stocks that gained over 1000 percent and another 9 that had gains over 900 percent.
The biggest winners in 1999 included firms such as Qualcomm, Free Markets, E-toys, Value America, Internet Capital Group and Commerce One. How many of those companies are still around today? One.
In the end, profits do matter.