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Tuesday, December 22, 2009

Corporate Profits And GDP

To be honest with y'all, I still have Q3 GDP about where I originally had it - at about 2.4%. However BEA now has it at 2.2% annualized. Oookay. Whatever. We never really know what GDP is within half a percentage point annualized anyway.

Looking at the final release for Q3 GDP (which will be revised for years to come), several things seem notable.
  1. The inventory build was just beginning; Q4 should be in the 3s. After that, it's up in the air.
  2. Without CARS, we would have been in trouble.
  3. Income is the main problem for both businesses and consumers.
  4. The US is still in better shape than way too many of its trading partners, which worries me on exports.
  5. I am slightly more positive on Q1 2010 than before (based on inventories). I am guessing it may come in marginally positive.
  6. This really does appear to be a mid-recession growth cycle; there seems little chance that Q4 will get us back to even on GDP.
  7. Oil prices are way too high.
1) Change in private inventories (see Table 3 on page 8) was still negative. This means that inventory was still clearing in aggregate but that production to replace that inventory hadn't caught up. This gives us a headwind for Q4 and a near guaranty of about a percentage point more on annualized GDP.

2) See page 13, Table 12, which covers corporate profits. Nonfinancial corporate profits increased 18.2 billion from Q2. Motor vehicles accounted for a 21.9 billion increase. Ergo, without CARS we were (insert description of your choice - mine is "left dead in the water").

3) Ooooh, pain. See Table 1 on page 6 for real disposable personal income (-1.4%) and go back to Table 12 for corporate income. Financial income really doesn't matter a flip right now in terms of getting the economy moving; I can assure you that most banks are taking their profits to bolster their balance sheets at this point. So non-financial profits matter; these are the guys that are going to create jobs and move money through the economy. And non-financial profits aren't increasing much (mainly due to PPI rises and poor consumer incomes). Nonfinancial profits for 06 were 1079.9 billion; they reached their low in Q4 2008 at 736.6 billion, and since they have been struggling up from the abyss at about a 20 billion per quarter pace. In Q3 they were 792.2 billion. This is not the recipe for corporate expansion; most larger corporations are still looking to trim costs. In fact, they have now moved into the restructuring phase.

4) One theory has been that a weaker US dollar combined with decent growth overseas would prove a bonanza for many US corporations. So far this hasn't proved so. I usually do a quarterly survey of a bunch of corporations with significant overseas sales, and I can tell you that they are running into problems. This is not great news for Germany or Japan either. Here higher food and fuel costs are hurting the ability of consumers to spend across the world. Government-funded stimulus programs have overcome some of the gap in 2009, but how long can governments run deficits to provide bonuses to consumers if they buy stuff? And fuel subsidies are going to prove increasingly unwieldy. Exports helped in Q3 but appear likely to be less helpful in the months coming.

5) Q1 - Hopefully my judgement on this hasn't been skewed by pure disgust with the seemingly endless recession. I do not see in the freight and rail reports much information that would make me believe inventories have been replenished. Granted, sales are quite slow in many industries. Nonethe less, there ought to be at least a residual half a real percentage point left for Q1. Or maybe I'm just hoping. I have been chasing what seems to be a missing half a percentage point for three months now; it is either an illusion (it disappeared with the collapse of small businesses) or it will show up in Q1 2010. If it doesn't, I think final Q1 GDP for 2010 will be marginally negative.

6) Gross domestic product. The way I count it, the height of current dollar GDP occurred in Q3 08 at 14,546.7. Q3 09 is now 14,242.1 - 300 billion short. The most we can probably hope for in Q4 is 200 billion plus, which will still leave us short. Real GDP peaked in Q2 08 at 13,415.3 billion; in Q3 09 it came in at 12,973 billion - about 440 billion short. NBER may opt for the comparison to their official start (the end of 2007). Even so, Q4 07 was 13,391 billion. We have a long way to go to get back to "the way things were".

7) Oil prices are suppressing world growth as they suppress disposable incomes. Thus a carrying price of $70 is not viable; it is sustained on theory that demand will rise as the world emerges from a very severe recession, but at the current price it is subtracting from world growth. It's notable that heating oil consumption in Germany (with a lower overall unemployment rate than most developed countries) has been suppressed by current prices. The subject came up in the Bundesbank monthly report. In the US, oil inventories are all above their average ranges for this time of year except for propane (which is running very low). And US imports have dropped a stunning 11.3% compared to last year - when US oil consumption dropped heftily. US domestic oil consumption has also dropped about 4.6% compared to last year. I don't care what anyone says about production; at these prices there is a hefty oversupply of world oil - in 2008 the US consumed about 22% of world oil, so an import drop of over 10% should equate to 2% plus on the international market. Current oil prices are the product of speculation and too much liquidity. Because oil prices directly affect food prices, world hunger will increase next year and economies with younger demographics will have less disposable income. This will subtract from export growth in a number of economies.

As an addendum, November rail freight still was lagging significantly on a YoY basis. Carloads were down 8.2% and intermodal was down 6.7% from November 2008. From November 2007 carloads were down 17.4% and intermodal was down 14.2%. November's Monthly Treasury report gives the 2.9% Medicare tax receipts at 15,896 million for 09 versus 08's 16,420 million (-3.2%). Fiscal YTD (October/November) 31,487 08/ 30,465 09 (-3.2%). Backing it out, 15067 08 Oct; 14569 09 (-3.3%). I was disappointed, indeed crestfallen, over November's receipts because now we are getting into the period at which YoY comparisons ought to be much improved as we are now comparing against the full onslaught of the recession. So far in December matters haven't improved; corporate tax receipts are still lagging those of December 08, and WIET is still lagging as well (94,332 Dec 18th 08/ 90,967 09). Seasonal hiring has been better this year, and the Census jobs should be showing up. I am beginning to get worried. Hopefully by February/March we will get back to even. The economy was hemorraghing jobs through this period a year ago. Raises and job stabilization ought to be getting us to the point at which incomes aren't falling soon.

It is true that early retirements come into play, but it is a mark of economic weakness that these workers don't get replaced. Early retirements are lowering official unemployment figures, but certainly don't help the fiscal situation. Until corporate profits rebound, we aren't going to see much in the way of improving employment. Let's look at some history from St. Louis Fred:

You will notice that a period of leveling of corporate profits generally precedes US recessions, and then is followed by a sharp rise in unemployment during recession as companies attempt to retrieve their fortunes by whacking away at their costs. The carnage in US corporate profits in this last recession was unprecedented in the Post WWII era, and you will note that the relative rise in unemployment was as well. It is true that US corporate profits are rising, but they haven't gotten back to where they were, and if you were to adjust for the recovery in financial profits, you would have a graph with a much smaller rise.

I have stared blearily at all manner of administrative and congressional proposals about how to develop jobs; it seems to me that they are missing the obvious. If non-financial orporations can make money, they will hire. If not, they won't.

Imagine that you are a farmer, or a mid-range businessman, and you read the news of the EPA's declaration that carbon is a dangerous pollutant. That means you have major additional regulatory hoops pending; that alone would induce extreme caution in developing your business. And then there's the question of whether you will be taxed additionally on your employees' health insurance, or taxed if they can't get it. Then there's the carbon tax proposal, and all manner of state-induced energy and pollution-related insanity. We have been sawing away at our own legs for some time now; it should not be surprising that we have trouble walking.

Remove the uncertainty, cut tax rates, and let the real economy work. Going back to Table 12 in Q3 GDP, domestic industry profits increased 100.7 billion dollars in Q3. Of that, 81.7 billion dollars came from financials (including the Fed) and only 18.9 billion came from non-financial industries. That's where the jobs are - in non-financial domestic industries. You cannot expect companies to expand in the US to sell to other nations if they are taxed and regulated to death here.

To turn this ugly little bug of a mid-recession growth cycle into a self-sustaining recovery, we need jobs, which will fuel retail sales, which will fuel job growth. We've got to climb back up the hillside we tumbled down. Here are real retail sales v unemployment rates, yea verily, it is like unto the previous graph because the US has a consumer-dominated economy:

We've got one real asset going for us. By this stage in the recession, a whole lot of people with money to spend need hats, gloves, underwear and the like, and this will bring them into stores. But we also have continuing job uncertainty in many corporations, which is preventing any sort of irrational consumer exuberance. We need the new jobs to kind of start climbing up that ladder, and to get new jobs we need to adopt a business-friendly policy.

Related to rail, YRC (Yellow Feight) will probably file for bankruptcy. They bought Roadway & USF and now have so much capacity it's crushing them. Each company could have made 15% cuts and managed, but Yellow cutting the same 15% after combining them with a huge debt load is not manageable.

"Current oil prices are the product of speculation and too much liquidity."

For what it is worth, I'm somewhat encouraged that gold dropped in price rather dramatically in the last month, that the $80 oil level appeared to be a brick wall, and that the momentum trade in TIPS appears to be fading.
This pretty much matches my gut feel from earlier in the year. :(
M_O_M, a little birdie told me at least some of the electric utilities are starting to build in an expectation of significantly higher natural gas prices in their planning for the next five years. This is opposite of what I've been conjecturing, but there's a special situation occurring.

Many of the Midwestern coal plants built 30 years ago are wearing out. My assumption has been that the economical thing to do would end up being refurbishment--but apparently they're being pushed to retire the plants for good, instead. The replacement capacity will be natural gas, with a few wind turbines for window dressing. There's a lot of new natural gas fields coming on-line, but the new capacity isn't free, and the expectation is that prices will rise significantly as a result. Granted, it'll crash again once the capacity comes on-line or the demand fails to materialize--I just hope the price swing doesn't raise the price of fertilizer production too much...

On a related note--Mark, I like the price action in gold, too. I'll be happy if it stabilizes in the 800 to 1000 range. Below 800 I suspect is deflationary territory, and there be dragons there. I'm positing that we'll see another run-up before all is said and done, though.

"On a related note--Mark, I like the price action in gold, too. I'll be happy if it stabilizes in the 800 to 1000 range. Below 800 I suspect is deflationary territory, and there be dragons there. I'm positing that we'll see another run-up before all is said and done, though."

I can't argue with any of that. I do think gold is overvalued at $1000, but if this is its blow off top then it will go down as a complete yawner in this era of bubble popping.

But what do I know? I thought I got a really good price in the 600s when I sold it all in 2006 (1/3 of my nest egg was in gold and silver since 2004). I've never been comfortable riding parabolas.
Mark I've never been comfortable riding parabolas

Everything's fine if you can keep the money churning. Of course, when you can't you hit hit bottom!
Hey, thanks to everyone for the info!!

Charles, the debt is a problem for MANY companies, which is why my hunch is that economic growth is in a particular danger spot for about the next 18 months.

John. Yup.

Neil - people don't understand the electricity crunch, which is real. It is true usage has dropped somewhat, but the aging plants are becoming ever more of an influence. There are a tremendous number of older plants - even nuclear - that are going to come off production over the next 10-15 years.

Regarding the NG plants, the situation is that NG is relatively cheap right now and favored by regulators. Approvals for a number of coal plants have been held up by court and regulatory action over the last couple of years. At one time I had a running count that went over one hundred.

And the nuclear plants are a problem too.

The worst issue is that NG has to be piped, and there are multiple areas in which the pipelines and depot capacity don't exist. So we don't have the infrastructure in place to use NG in a number of areas, although according to EIA there has been a lot of interregional building since 2000.

Hopefully feedlines to power plants can be run pretty quickly, and perhaps a few more storage depots created. It is difficult in the older urbanized areas to add some of this capacity.
Mark - regarding oil and gold prices. I have seen some more favorable shifts in credit (small, but favorable) and I think demand for money will be a bit better next year. One of the factors affecting oil and gold prices seems to have been the dawning realization that risks aren't over and a consequent rise in the demand for treasuries and the dollar.

Sigh. Bad loans are the gift that just keeps giving and giving and giving like a malevolent Energizer Banker.

I have seen some more favorable shifts in credit (small, but favorable) and I think demand for money will be a bit better next year.

I don't mind sitting in cash. I see no great need to place big bets on anything right now. I'm certainly not going to lock in 0.33% on a 5-Year inflation protected treasury. I don't see value there for the deflationists, the inflationists, the bulls, or the bears.

Hmmmm, I'll have to think about some sources for good info on pipeline infrastructure.

I'm not sure how much need there is for new urban infrastructure--new generating capacity is largely being built up in out-of-the-way locations. My impression has been that local pipeline is pretty cheap to add, and the cost of inter-regional is largely in the regulations and lawsuits. If the political environment improves regarding natural gas, then infrastructure follows quickly.

LOL, the Energizer Banker--pounding the table over and over for a bailout!
Neil - if you've got any I'd love a pointer. Some of my info I have taken from NERC reports. However checking the EIA website seems to show that there has been building.
M_O_M, I'll let you know what I come up with. My info to date has all been via my flock of little birdies, but I'm getting conflicting messages now, which calls for numbers. I'll try to find some numbers that indicate what people are actually putting their money down on. This is beginning to become a critical question.
MOM, I have an interesting data point for you on natural gas. One of our vendors that builds combustion equipment (used in a lot of industries for natural gas service on equipment) is returning to 5-day work weeks. Word is that demand for the equipment is picking up (on the east coast first, as it usually does in that industry segment). First hopeful sign I've seen from any of our vendors.
Business friendly policies? With this Administration it's the Five Year Plan in Four years.

Arcane reference, but you're up to it!
CF - Five Year Plan? Does that have something to do with Mao Christmas balls on the WH tree? Because, nothing, absolutely nothing, says "Merry Christmas" like Chairman Mao's face.

I was inspired to set up my backyard iron smelter in January - it's my NY resolution.

I have also vowed to kill every fly I see for the great and glorious people's health care revolution.
John - thanks. I know that port traffic in several East Coast ports is doing much better.

I think we could pull slowly out of our doldrums if it weren't for the government's insane urge to meddle. I'm seeing some real winter wheat sprouts out there.
The Five-Year Plans for the National Economy of the USSR (Russian: пятилетка, Pyatiletka) were a series of nation-wide centralized exercises in rapid economic development in the Soviet Union. The plans were developed by the Gosplan based on the Theory of Productive Forces that was part of the general guidelines of the Communist Party for economic development. Fulfilling the plan became the watchword of Soviet bureaucracy.
Here's another data point on consumers replacing worn-out items: I have gone shopping for a new dish drainer, and have marched right out of a number of stores because I can't find a drainer in a color that I would want to look at every day. Rubbermaid's current palette is black, white, off-white, dark gray, and dark red. While these are colors that will go well with granite countertops, they are not exactly cheerful colors that will lift the worried consumer's spirits. So I am sticking with my goldenrod drainer that must be nearly as old as I am.

My mother-in-law recently repainted her kitchen, and the paint colors were also dismal and depression-inducing.

I half-seriously think that we're stuck in a economically disastrous color trend, and that it's going to drag on for some time, because people will be reluctant to rip out their expensive granite countertops to move on to the next style.
Granite countertops--there just might be an indicator there. I used to know someone who worked for Cold Springs Granite out a little ways west of here. I wonder what their production schedule looks like?
Peggy - I'm laughing, but there is some truth in that. Recovery is going to come from socks, shoes, pots, pans and appliances rather than from housing sales.

Gordon - not too good. There are fire sales on granite countertops. For kicks, last month I looked up some supply places.
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