US corporate profits fell a staggering 11.5% on the year in the last quarter of 2015, according to the national accounts. This number is artificially high, however, after adjusting for the one-off distortion, profits still fell 7.6%. As can be seen below, a plunge in profits of this magnitude is usually associated with a recession.
First of all it is important to note that a lot of the fall in profits comes from energy firms. In fact, S&P profits excluding energy firms have remained fairly constant. That said, the national accounts (i.e. the entire economy) include a larger pool of businesses and these show that non-energy firms do in fact account for a substantial share of the decline in profits. Secondly it is always easy to isolate the industry most affected but we must remember it was “only” tech profits falling before the dotcom bubble and “only” financials that were taking a hit before the financial crisis.
More important is that profits tend to lead the rest of the economy, as well as the growth in wages, as can be seen below:
So why is this happening? Other than the obvious plunge in oil, firms are facing decreasing margins from higher unit labour costs. Persistently poor productivity has pushed up the cost of labour despite relatively benign rises in nominal wages this cycle:
However, it is not all doom and gloom. Usually rising wages and inflationary pressures push the Fed into a hiking cycle that ultimately leads to a recession. This time round, unit labour costs are rising due to weak productivity. The Fed remains ultra accommodative, which is especially evident after Yellen’s recent speech at Economic Club of New York. Easy monetary policy is aimed at reflating the economy which will ultimately provide firms with larger pricing power.
Lastly, there are signs that the core issue, oil and ultimately industrial production, is showing tentative signs of a bottom. The majority of the Fed’s regional manufacturing surveys have surged recently as well as the ISM manufacturing survey, whilst hard manufacturing data in US as well as Europe has picked up.