Subject: David Hale: Positive Outlook for US Profits
From: "David Hale" <[email-masked]>
To: <[email-masked]>
Date: Thu, 29 Dec 2011 19:54:47 +0000 (GMT)

Dear Clients,

Please find attached our latest bulletin, "The Outlook for US Profits" which argues that a strong GDP growth outlook for 2012 should produce continued record profit levels throughout the year--although risks to the outlook do remain.

Additionally, Lyric Hughes Hale has written an article for the Huffington Post, "The Coming Accidental War with Iran," that analyzes the current geopolitical dynamics surrounding Iran. It concludes that war with Iran could be the black swan event of 2012 that would cause an already tenuous global economic recovery to unravel. The link to the article is as follows: http://www.huffingtonpost.com/lyric-hughes-hale/the-coming-accidental-war_b_1170574.html

Happy New Year to you and yours. We appreciate your business, and the opportunity of working with you throughout the year. You will be receiving our comprehensive 2012 Forecast next week.

Best regards,
David Hale
Chairman

David Hale Global Economics, Inc.

847-386-6009 (tel)
847-386-6011 (fax)
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http://davidhaleweb.com
http://whatsnextbook.com

NEWS: Yale University Press has published “What’s Next?” Unconventional Wisdom about the World Economy, by David Hale and Lyric Hughes Hale, available now

About "What's Next?":http://whatsnextbook.com

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The Outlook for US Profits
December 29, 2011 • Volume 08.20
By David Hale

The US economy has had a very contradictory recovery since 2009. The growth rate of real GDP has been a lackluster 2.4% despite the severity of the preceding downturn. The growth rate of corporate profits, by contrast, has been the most spectacular in the modern era. Profits have more than doubled since the trough in the fourth quarter of 2008. The profit share of national income has risen to a record 13.0% of GDP from 6.9% during the fourth quarter of 2008. The domestic nonfinancial profit share of GDP is 7.2% and the domestic financial share is 2.8%. Domestic nonfinancial profits reached a trough of 4.1% during the second quarter of 2009 while domestic financial profits had a loss equal to 0.7% of GDP during the fourth quarter of 2008.

The profit rebound has been driven by three factors. First, the corporate sector slashed costs by laying off over 8.8 million workers during the recession. The job losses set the stage for a large gain in productivity. It rose by 8.6% between the first quarter of 2009 and the second quarter of 2011. As a result of these large productivity gains, unit labor costs fell 3.5% during this same period. While unit labor costs fell, the corporate sector's price deflator rose by 3.3% since the trough in early 2010. Secondly, the Federal Reserve's monetary policy has significantly reduced corporate borrowing costs. They have fallen from just under $300 billion during 2008 to only $100 billion. As the Fed has committed to holding interest rates close to zero until mid-2013, they are likely to remain subdued for the time being. Thirdly, the profit gain may reflect the fact that the growth rate of nominal income during the recovery has been 1.5% larger than the growth rate of nominal GDP.  There are likely to be GDP revisions next year which could increase the growth rate of nominal GDP and reduce the profit share of GDP.

The profit decline during the 2008-09 downturn was 38.9%, or the largest in the modern era. The profit decline during the recession of the mid-1970s was only 12.5%, while the profit rebound during the first nine quarters of the 1975-76 recovery was 54.4%. There were two recessions during the period 1979-82, and the overall profit decline was 16.2%. The growth of profits during the first nine quarters of the recovery was 63.8%.  There was only a 7.8% profit decline during the 1990-91 downturn, so the profit rebound during the first nine quarters of the recovery was just 17.4%. The technology crash during 2000 and 2001 produced a profit decline of 10.8%. The profit rebound during the first nine quarters of recovery was 37%.  There was a good gain in productivity during all of these recoveries, but unit labor costs followed a more diverse path.  They rose over 10% during the first nine quarters of the 1975-76 recovery, they rose just 3.2% during the 1983-84 recovery, they rose over 5% during the 1991-92 recovery, and they fell 0.5% during the 2002-03 recovery. The recent decline in unit labor costs reflects the fact that the government's index of wage compensation is still below its previous peak during the first quarter of 2008. As a result of this success in restraining unit labor costs, the Commerce Department's index of unit profits has increased nearly 76% since the second quarter of 2009. The gain in unit profits during the first nine quarters of the 1975-76 recovery was 47.1%, the gain during the 1983-84 recovery was 52.4%, and the gain during the 1991-92 recovery was 17.9%. The recovery from the technology crash of 2000-01 was the only one which matched the recent upturn, when the unit profit index rose nearly 82%.

Domestic nonfinancial profits have increased 92.7% from their trough during the second quarter of 2009, and are now at a record high. Domestic financial profits have increased 119.4% from levels during the first quarter of 2009, but have not regained their previous peak. The corporate sector's foreign profits have increased 31% from the trough while profits earned by foreign companies in the US have increased 119%. The manufacturing sector's profits have increased 132% from the trough during the second quarter of 2009. Durable goods have swung from nearly zero profits during the first quarter of 2009 to $113.6 billion during the third quarter of 2011. Nondurable goods profits have increased 55.5% from the trough. Retail profits rose 43% during the first six quarters of the sector’s recovery, but have declined at an erratic pace during recent quarters. 

The foreign profits of US companies could be vulnerable to the downturn now occurring in the European economy. In 2007 Europe accounted for 54% of the foreign income of American firms compared to 22% for Latin America and 13% for the Asia-Pacific region. Europe accounts for 56% of US foreign direct investment.

The major casualty of the rising profit share of national income has been wages and salaries. Their share of nominal GDP fell to 44.0% during 2010 from 48.8% during 2000, 50.4% during 1980, and a previous peak of 53.9% during 1970. If the wage share of national income was at levels prevailing before the recession, it would be almost $400 billion higher. If it were at levels which prevailed before 2000, it would be $780 billion higher. The declining wage share of national income has resulted from a large increase in the share of compensation which derives from benefits such as health insurance. They have risen from about 3% of national income during the late 1940s to 12% since the 1980s. The globalization process has also enhanced the ability of corporations to restrain costs while the power of trade unions has declined. 

The US stock market fell sharply during the summer because of investor concerns there could be a double dip in the economy which might produce a 20-25% decline in corporate profits. The resilience of final demand since the second quarter has now calmed those fears. The S&P 500 measure of profits rose to a record high of $25.32 during the third quarter. As a result of the loss of confidence which resulted from falling equity prices during July and August, analysts are projecting profits of only $24.34 during the fourth quarter. Ninety-six companies revised their fourth quarter profit forecasts downward while twenty-seven have revised them upward. Since real GDP growth during the fourth quarter could be as high as 3-4%, these profit forecasts are too cautious. Profits could easily exceed $25.00. Analysts are projecting that profits could rise to $28.34 during the fourth quarter of 2012, or a level 16.4% above their forecast for the fourth quarter of 2011. Such a gain would be larger than the 11.0% uptick analysts are projecting for 2011. The S&P profit gain during the four quarters of 2010 was 27.8%. S&P profits have increased 150.1% since the first quarter of 2009. S&P profits recorded a loss of $0.09 during the fourth quarter of 2008. The S&P profit gain at this stage of the post-2001 recovery was 84.3%.

The outlook for profits during 2012 will depend heavily upon pending decisions about US fiscal policy. Will Congress accept the president's proposal to continue the 2011 payroll tax cuts and extended unemployment benefits for the full year? If they do, the GDP growth rate should remain in the 2-3% range. If they do not, the household sector will suffer a $160 billion income loss, and the economy's growth rate could dip to 1% during the quarter that the tax cuts are lost. In December, the Congress agreed to extend the tax cuts through February. They will probably agree to extend them a full year when they return in January.

The resilience of profits during the 2011 slowdown suggests that profit growth will remain positive during 2012. If the economy can achieve a growth rate in the 2.5-3.0% range, there could be a profit gain of 8-10%. If the economy again slows sharply, the profit gain may be only 2-3%. The risk is that declining output growth could depress productivity and erode profit margins.

The large increase in corporate profits is the primary explanation for why the US equity market has doubled since March 2009. Investors have overlooked subdued macro economic data because of the micro economic performance of the corporate sector. If profits continue to surprise on the upside, the stock market will continue to rally. But if slower growth depresses productivity and profit margins, the equity market will be vulnerable. 

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