Are The Bears Returning To Wall Street?
For months, the Biden Administration and the Federal Reserve have told us that this Economy is just like Goldilocks. The tale of a little girl who finds that breakfast has been served. And what’s more, it’s “just right.” Like the Economy, it’s not too hot, and it’s not too cold. President Biden tells us that we’re “building back better.” Over at the Federal Reserve, Jerome Powell tells us that endless monetary tightening will solve the inflation problem without causing undue slowing in the Economy. It’s all “just right.”
Many of us feel that things aren’t “just right” at all. In reality, this Economy is slowing dramatically, and we expect to see the most dramatic example this morning when the Bureau of Economic Analysis releases its latest report on Corporate Profits.
CORPORATE PROFITS
Corporate Profits (blue, left scale) Interest Rates (Fed Funds, red, right scale)
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If Wall Street analysts are anywhere close in their projections for today’s profits, what we are beginning to see is genuinely staggering. This year profits have been the weak sister in economic reports. After having peaked last year at over $2.5 trillion, American Corporate Profits have fallen 2.7% in Q1 and 5.9% in Q2. Roughly speaking, profits declined the previous quarter by nearly $150 billion. And remember, that’s income, so it is apparent that companies will have to cut back, likely shelving new projects, reducing sales projections, and probably laying off staff.
UPDATE: Although Corporate Profits beat Wall Street Expectations, rising a tepid 1.6%, that did little to blunt the basic thesis that Corporate America is suffering. The last time we saw Profits decline like this, the Economy was either in a Recession or a Pandemic.
Ask any economist what their favorite indicator for the stock market is, and they’ll likely tell you it is Corporate Profits. That’s because, in the economic sense, what investors (not speculators) are buying when they purchase a stock is that company’s future earnings. The investor hopes earnings will continue to grow and thereby cause the price of their stock to rise. A direct, long-term correlation exists between stock value, revenues, and corporate profits.
If earnings are rolling over and declining, that would remove one of the fundamental supports for this bull market. Combine this with the latest revision to employment (see: https://www.valueside.com/2023/08/25/revised-the-economy-lost-70k-jobs-in-march/), and it paints a highly dire picture.
Overall, what we’re seeing is a decline in employment after revisions. Remember, the Bureau of Labor Statistics revised the March Employment Report and has yet to revise April, May, June, and July. There will likely be more surprises when those revisions are announced.
And now we see corporate profits declining; we’ll wait to see if that’s confirmed with this morning’s report. So what’s Washington’s response?
POLICY IMPLICATIONS
Two major initiatives are coming from Washington, the first proposed and the second implemented.
President Biden has proposed raising the Corporate Tax Rate by 7%, from the current 21% income tax rate to 28%, at current corporate revenues, reducing net income by roughly $160 Billion. It would further decrease the corporate earnings that are the central driver of the Economy. Fortunately, this tax hike remains a proposal and has yet to be acted on by Congress.
On the other hand, the Federal Reserve has fully implemented its monetary policy, and its effects are impacting the Economy now. As you know, the Federal Reserve has been hiking interest rates for a year and a half; their current interest rate is 5.5%. For corporations (and individuals), this has meant that their “cost of funds” has risen by over 500 basis points. Loans with meager interest charges, perhaps less than 1%, now have an interest rate of 5.5% or greater. That’s an increase in interest rate charges of nearly $650 billion per year on the outstanding Corporate Debt of $12.7 Trillion. And, because loans must be paid first, this is a direct reduction in Corporate Income.
WILL THE BEARS COME HOME?
So, overall, it’s becoming more challenging to see the Economy with “Goldilocks’s Glasses.” If today’s corporate profits Report is as dire as most on Wall Street estimates, it shows that we are at the weakest point since the Pandemic, with Profits declining at nearly the same rate as back then. Combine that with further “revisions” of employment by the Bureaus of Labor Statistics, and you have two of the most essential economic components that are struggling.
Further, the one remaining bright spot, consumer spending, would be the real outlier, and it’s hard to imagine how consumers could continue to spend in this kind of environment.
UPDATE: When consumer spending was announced this morning, it showed a 59% drop in Q2 from the previous Quarter. This was a real surprise and indicates that this economy is becoming very sick.
It may also mean that when the Bears return to Wall Street, they’ll find that someone’s been eating their porridge.
