Joseph G. Carson

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The profits puzzle is no more. A recent report by the Bureau of Economic Analysis (BEA) stated that the primary reason that the GDP measure of operating profits does not show the "large run-up in profits" in other "popular measures" (e.g., S&P profits) is because it does not include capital gains, while other measures do. And it’s happening again.

BEA periodically publishes a report that provides a "conceptual bridge" to gauge the differences between the growth rates of the GDP measure of profits and S&P 500 reported profits.

According to BEA there are several accounting principles that affect measures of receipts and expenses and their timing, and "comparisons can be meaningful" with GDP & S&P 500 operating profits only if adjustments are made for the differences.

The adjustments fall into two broad categories: capital gains (net of losses) and bad debt expenses. Trading gains and losses are considered part of S&P 500 operating profits, but not part of GDP profits since they reflect a change (gain or loss) in the valuation of existing asset. Also, bad debt expenses are included in the GDP measure of profits since these reflect an adjustment to corporate balance sheet, while the write-down of existing assets are excluded from S&P 500 profits.

In past reports, BEA has published a series on GDP profits (after tax) and then an adjusted GDP profit series, netting out the bad debt expenses and adding back the capital gains (net of losses) in order to make the GDP profit series more aligned with the financial accounting basis for S&P profits.

According to the data published by BEA, capital gains (net of losses) run about 3 times larger than bad debt expenses during periods of economic growth and rising asset markets. But during periods slow growth or recession and falling risk markets capital gains (net of losses) can run equal to or even below bad debt expenses. Also, capital gains (net of losses) can ran as high as 30% of GDP measure of profits during rising risk markets.

Yet, it’s the "growth rates" that BEA believes offer the most meaningful insight when assessing the differences between adjusted GDP and S&P profits measures. And the differences in growth rates can be quite substantial, and in some cases the profit series move in opposite directions.

For example, in 2000 during the peak of tech bubble S&P operating earnings showed a double-digit gain in earnings, while the adjusted GDP measure of profits posted a decline. And in 2008 (financial crisis) the S&P operating profit declines was substantially larger than the GDP adjusted measure.

A senior BEA official said the next reconciliation report on GDP and S&P 500 profits would not be released until late 2020. Nevertheless, its already been well documented that capital gains are the key "wedge" between GDP and S&P profits and represent the most likely source of 2014 to 2019 outperformance of S&P 500 operating earnings. And its also important to note that while capital gains provide an extra boost to the growth rate of S&P 500 operating profits during rising risk markets they also represent a huge drag during down markets.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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The profits puzzle is no more. A recent report by the Bureau of Economic Analysis (BEA) stated that the primary reason that the GDP measure of operating profits does not show the "large run-up in profits" in other "popular measures" [...]

"Solving" The Profits Puzzle

Charles Steindel

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The Philadelphia Federal Reserve Bank's estimates of state coincident activity for August show some increased dispersion and, overall, some signs of softening in economic growth. Over the last 12 months, 29 states show increases in their index in the 2 to 4 percent range—down from counts over 30 in that middle group in recent months. 7 states were at 4 percent or higher; 14 were lower than 2 percent, with Michigan reporting a decline. Western states were again generally stronger than the east; with Nevada at the top, with a 4.7 percent gain. Two large Eastern states—Georgia and Florida—did report growth of 3.5 percent. The weaker states tended to be in the middle portion of the nation, though New York was also in that group.

Over the three months ending in August, 24 states had gains of less than .5 percent, with 45 declines, with Kentucky's index down nearly 1 percent over that period. 14 states, though, had gains of 1 percent or more; these were in a wide swath literally from Maine to California (and with Alabama in the group just touching a southern border). Montana was again the state with the highest growth in this category. Its 2.48 percent increase was virtually the same as the preliminary 2.49 percent rise in its index reported for the April-July period

Montana also, (again) had the largest one-month increase in the initial results for August. 8 states saw declines (the initial report for July had 12 in this category), with drops of 2 percent or more in Delaware, Wyoming, and Kentucky.

The upshot from this survey is comparable to other recent reports. Growth is continuing, but with a fair number of states seeing cooling-off, and fewer showing extremely rapid growth. In the very largest states, Texas, California, and Florida still report strong numbers, though none of them were in the very top group; however, the figures from New York have been soft.
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The Philadelphia Federal Reserve Bank's estimates of state coincident activity for August show some increased dispersion and, overall, some signs of softening in economic growth. Over the last 12 months, 29 states show increases in [...]

State Coincident Indexes

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Operating profits for the overall economy have been essentially flat since 2014. Yet, during the same 5-year period operating profits for the S&P 500 companies are estimated to be up by a third.

Taken at face value, the profits data paints a picture of rising earnings for the companies that comprise the S&P 500 index while profits for millions of other firms are stagnant, if not contracting. How can that be? Are the earnings of S&P 500 companies "real" or are accounting gimmicks inflating them?

According to corporate profit data from the Bureau of Economic Analysis (BEA) operating profits for all US corporations (large and small and public and private) totaled $2.113 trillion in Q2 2019 essentially unchanged from the 2014 full year profit figure of $2.120 trillion.

Over the same 5-year period, the operating profits of S&P 500 companies have increased from $1.004 trillion in 2014 to an annualized estimated figure of $1.333 trillion in Q2 2019, and increase of 33%.

Both estimates of profits calculate earnings as the difference between receipts and expenses. Yet, the profit reports are based on two different accounting frameworks, financial and tax accounting.

Companies' use financial accounting to report their results, while tax accounting results is the primary source for the GDP measure of profits. As a result, differences between the two profit measures can result from the timing of when receipts and expenses are recorded, as well of what is included and not included in receipts and expenses.

For example, the GDP gauge of operating profits adjusts for misreported and/or overstated measures of current income. Income or losses derived from capital sales are not part of the GDP measure of profits because they reflect the sale of existing assets and GDP is only measuring the profits from current production, and not the change in the valuation of items that were produced in previous periods.

Yet, S&P 500 profits, which are based on a financial accounting basis, do include income derived from capital sales, and other financial flows and adjustments as well.

At the currently reported levels for Q2 2019 S&P 500 profits amount to a record 63% of overall operating profits for all US companies. In the past 30 years there is only one other period when the share of S&P 500 earnings topped the 60% level. That occurred in the late 1990s when the large gain in reported S&P 500 profits was largely driven by capital gain income. And, during that period the GDP measure of operating profits followed a similar pattern to that of 2014 to 2019---flat to slightly down.

Corporate profits are an important measure of the economy's overall performance as well as benchmark for the financial health of the corporate sector. The overall profit data raises questions about the general health of corporate sector. Moreover, the relative surge in S&P 500 earnings appears to be driven not by core operations and the experience of the late 1990s would argue that they unsustainable in their current form.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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Operating profits for the overall economy have been essentially flat since 2014. Yet, during the same 5-year period operating profits for the S&P 500 companies are estimated to be up by a third. Taken at face value, the profits data [...]

The Profits Puzzle

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State labor markets were mixed in August. Five states experienced statistically significant increases in payroll employment, with 3 (Arizona, Georgia and Kansas) .4 percent or higher. California had the largest numerical gain, but the 34,500 increase was a fairly small .2 percent in light of the number of jobs in the state. On the negative side, Oklahoma's 8,700 loss (.5 percent) was the only one deemed statistically significant, but 15 other states report declines in payrolls (Indiana's 8,500 loss was nearly as large as Oklahoma's. It's a bit surprising that a loss of this magnitude--.3%--wasn't seen as statistically notable). 12-month job gains have also cooled off. Nevada is now the only state with a 3 handle on its percentage gain (3.0, to be exact). Nineteen states, mainly in the Middle West and Northeast, report job growth of 1.0 percent or less over the last 12 months. New York, Pennsylvania, Ohio, and Michigan are in the group (the 12-month point increases in Pennsylvania, Ohio, and Michigan were not statistically significant). It remains the case that Western states are the leaders in job growth; Alabama and Florida are the only states in the East that have seen payrolls expand at 2 percent or higher. On the positive side, for the first time in some while, all states report some growth in jobs over the last year.

Some divergence has recently developed between the national job figures and those reported at the state level. Over the last 6 months the national count has risen by 898 thousand; the sum of the state figure has a gain of 1.056 million. Divergences of even larger magnitude are not uncommon; the currently reported data shows an increase of 1.296 million for the national total over the 6 months ending in September 2018, while the sum of the states figure is shown as rising only 713 thousand in that period.

The household survey figures show that low unemployment rates are common across the nation. Alaska remains the great high side outlier, with a rate of 6.2 percent, but Mississippi and Arizona had rates of 5 percent or higher. 12 states had unemployment rates under 3 percent, with Vermont's rate remaining an astonishing 2.1 percent. Puerto Rico's rate fell .4 percentage points to 7.7 percent, and the island's job count, though down slightly from July, was above August 2018.
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State labor markets were mixed in August. Five states experienced statistically significant increases in payroll employment, with 3 (Arizona, Georgia and Kansas) .4 percent or higher. California had the largest numerical gain, but the [...]

State Labor Markets in August

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The August report from the Institute of Supply Management on the manufacturing sector showed a sharp drop in overall activity, with very few firms reporting gains in new orders and production. The manufacturer's purchasing managers' index has one of the best records of foreshadowing recession so the drop in the composite index in August, although its only for a single month, highlights how vulnerable the overall economy is at the present time.

In August, the composite index dropped 2.1 percentage points to 49.1, falling below the all-important threshold of 50 (the so-called dividing line between growth and contraction) for the first time since 2016.

Four of the five components that comprise the overall index dropped in August, led by declines in employment, production and new orders. The only component that rose in the month was inventories. That's a bad mix, as it signals more weakness in manufacturing in coming months.

The new orders index at 47.2, dropping below 50 and also below the composite index of 49.1 is a troubling development as the orders index usually offers insight in the future direction of the overall index.

In August, only three industries out of 18 manufacturing industries reported gains in new orders, and only 4 out of 18 reported gains in production. Combined, these numbers on firms reporting gains in orders and production match the lowest of the current cycle and also are marginally below the levels that were in place in the fall of 2009.

To be fair, the signal from the purchasing managers survey has to be sustained over a span of several months for it to confirm a sharp slowdown or an outright decline in economic activity. Yet, the clock is ticking and the outcome of the US/China trade talks could easily tip scale one way or the other, but in the meantime the key takeaway from the August purchasing managers survey is that a number of companies earnings report will be weaker than expected for Q3.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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The August report from the Institute of Supply Management on the manufacturing sector showed a sharp drop in overall activity, with very few firms reporting gains in new orders and production. The manufacturer's purchasing managers' [...]

US Purchasing Managers "Recession" Warning---- Few Firms Report Gains in Orders and Production

Outlook strengthens for US while it weakens for other major economies

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Inflation surprising to upside in the US; by contrast to the downside in the euro area

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Blue Chip forecasters expect significant monetary easing this year except in Japan

Euro area economy stagnating while US grows above trend

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Chinese population declines in 2023 for second consecutive year

Outlook for US GDP growth on the rise; declining in euro area, Japan and China

There are still 1.4 job openings for every unemployed person in the US

US PCE inflation over the past six months has slowed to the Fed's 2% target

FOMC think rate hikes are done and looks for 75bps of decline in 2024

Weaker economic data surprises pushing down US interest rates

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Recent decline in US inflation expectations helping to lower interest rates

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Systemic stress on rise in Europe, less so in US

Recent increase in longer-term US market interest rates not due to inflation

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Ken Matheny

**The US economy is stronger than suggested by the “soft” 1.6% increase in GDP in the first quarter, while a sharp upturn of inflation puts Fed rate cuts on hold for at least several months.**

**Look to final sales to private domestic purchasers, not GDP, for a better indication of the economy’s underlying strength.**
The initial (“advance”) report of the national accounts for the first quarter of 2024 should be interpreted carefully.  Looking beyond the headline figures, the economy’s underlying growth momentum was notably stronger than the disappointing figure of 1.6% quarterly GDP growth in the first quarter.  GDP growth was held down by declines in components that tend to be more volatile  --- inventories and net exports --- in contrast to solid growth in other components, including consumer spending and private investment.  Personal consumption expenditures (PCE) posted solid growth (of 2.9%).  Business fixed investment also rose 2.9%, while residential investment jumped 13.9%, continuing a recovery that began in the second half of 2024.

A more telling indicator of the US economy’s underlying strength is final sales to private domestic purchasers, which rose at a solid 3.1% annual rate in the first quarter, virtually identical to increases in the third and fourth quarters of 2023 of 3.0% and 3.3%, respectively.  This is a clear if preliminary indication that the economy retains solid momentum for growth.

Together, declines in inventory investment and net exports subtracted 1.2 percentage points from GDP growth in the first quarter, but those components are not likely to continue to subtract large amounts from GDP growth on an ongoing basis, even though quarterly swings could be significant (in either direction) from time to time.  The level of inventory investment ($35 billion in the first quarter) is broadly sustainable, suggesting that repeated large declines are not the most likely outcome.  Net exports have been in a sideways waffle since the second half of 2022.  Future large declines are possible if foreign demand were to collapse or the dollar were to appreciate sharply, but neither of those outcomes appear to be highly likely at this juncture.  In short, the 3.1% growth in final sales to domestic purchasers is a better indicator of underlying strength in demand than the smaller 1.6% increase in GDP in the first quarter.

Of course, GDP and other estimates are subject to revision, so the picture of first-quarter growth could be altered in coming months.

**Inflation surged in the first quarter, nearly eliminating any prospect for a Fed rate cut prior to this fall.**
Another major component in today’s report on the national accounts was a disturbing increase in consumer inflation.  The price index for personal consumption expenditures (PCE) rose at a 3.4% annual rate in the first quarter, the largest increase since the first quarter of 2023.  Meanwhile, the core PCE price index rose at an even higher 3.7% annual rate in the first quarter, far above the increase of 2.0% in the final two quarters of last year.  This is a direct challenge to any hope that the Federal Reserve will begin to lower interest rates in coming months.  As of the first quarter, the annual (four-quarter) increase in the core PCE price index was 2.9%.  It is likely that tomorrow’s report on monthly PCE will show annual (12-month) inflation at or slightly above February’s 2.8% reading.

The Federal Open Market Committee (FOMC) will almost certainly not begin to seriously contemplate rate cuts without clear indications that inflation is easing and well on track to fall to 2% over time.  The latest inflation figures suggest that progress on bringing inflation down has stalled.  It will take more than one or two “good” monthly inflation reports to convince policymakers that it is appropriate to begin cutting interest rates.  This makes any rate cut prior to this fall a low probability outcome and adds to the risk that there might not be any Fed rate cut in 2024.

240425KM.jpg

First-Quarter 2024 National Accounts

The Federal Reserve Bank of Philadelphia’s state coincident indexes in March showed some moderate variance. Four states were down slightly from February. The largest increase was Arizona’s .8 percent; three other states (Iowa, Delaware, and Vermont) had gains of at least .5 percent. Over the three months since December, Massachusetts was up 1.9 percent, while 8 other states (scattered across the nation) rose more than 1 percent. Over the last 12 months, Massachusetts again led, with an increase of 4.9 percent, while New York’s 3.6 percent was a fairly distant second. 5 states were down over the period, with Montana’s slump continuing, with a loss of 3 percent.

The independently estimated national figures of growth over the last 3 months (.75 percent) may be a touch higher than the state estimates would have suggested, but the 12-month figure (2.9) percent) looks to be roughly in line with the state numbers.

State Coincident Indexes in March 2024

State labor markets were little-changed in March, but on the whole the report looked better than February’s. Only five states had statistically significant gains in payrolls (Arkansas, Georgia, Kansas, Kentucky, and Virginia), with two having .5 percent increases (Arkansas and Virginia).  The other states, and DC, had insignificant changes, though numbers had point increases comparable to those that were deemed significant. For instance, California had an increase of about 30,000, though that was less than .2 percent, and New Jersey was up around .3 percent.

Six states had statistically significant declines  in their unemployment rates in January, while one had a significant increase. The only move larger than .1 percentage point was a decline of .3 percentage point in Arizona.  The highest unemployment rates were in California  (5.3%), DC (5.2%) and Nevada (5.1%). States with unemployment rates of 4.8% (one point above the national rate)were Illinois, New Jersey, and Washington.   Maryland, Minnesota, Nebraska, New Hampshire, North Dakota, South Dakota, Utah, Vermont, and Wyoming  had rates of 2.8% or lower, with North Dakota at 2.0%.

Puerto Rico’s unemployment rate moved up to 5.8 percent, while the island’s job count moved up by 2,200.

State Labor Markets in March 2024

Viewpoints: September 2019

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"Solving" The Profits Puzzle

State Coincident Indexes

The Profits Puzzle

State Labor Markets in August

US Purchasing Managers "Recession" Warning---- Few Firms Report Gains in Orders and Production