Yesterday’s post by James Montier did much of the heavy lifting on the corporate profit outlook, but I wanted to add a few details to the future outlook since I run a profit model based on similar thinking. We use the Kalecki profit equation to arrive at an approximation of future profits. I’ll save the mundane accounting details for another day, but the basics are rather simple as Montier outlines:
Pro?ts = Investment "“ Household Savings "“ Government Savings "“ Foreign Savings + Dividends
If you’re really looking for a detail outline here I would highly recommend this piece at the Levy Institute.
What you’ll notice in Montier’s work is that private investment is usually the driver of corporate profits. But these aren’t normal times. The effects of the balance sheet recession are still very much with us and the recovery is proving painfully slow. While private investment is improving it remains well below historical levels of 7.5% of GDP. The good news is that mean reversion is working in our favor and the current level of 4% of GDP is likely to continue climbing. Unfortunately, we’re coming off of very low levels and corporations remain cautious in their approach to the economy.
The key takeaway from the Montier piece is that corporate profits have been largely driven by budget deficits in recent years. This has been the single most important understanding of the balance sheet recession. If you understood that large budget deficits would help offset the de-leveraging process then you had a huge advantage over those who thought we were in for one sustained depression. Unfortunately, the risks are mounting in this regard and corporate profits are at the top of the list.
As both Montier and Richard Bernstein have recently noted, the outlook for profits is looking tepid at best. I’ve run two scenarios through my profit model. The first scenario assumes continued mean reversion in private investment, growth in dividends, flat household saving, marginally deteriorating current account and the CBO’s current 2013 deficit outlook. It’s a very reasonable outlook although I’d argue that there is likely upside in the deficit since I believe politicians are likely to continue many of the current policies as the economy remains weak. In the second scenario I’ve assumed more modest cuts in the deficit, a stronger investment boom, flat household saving, flat current account and modest dividend growth. This, in my opinion, is a more likely outcome. The results follow:
The key point here is that without a big debt boom and an enormous and probably historic investment boom the corporate profits picture is likely to come under more pressure as we head into 2013. And if the budget cuts are sharper than expected we can expect a substantial hit to corporate profits. Stay tuned. Budget updates will continue to play heavily into this outlook as the year plays out….
I wonder if anyone has written a spreadsheet to model future corporate profits, in which one could play with various assumptions, which they would allow the public to download and use?
Does it really matter anymore where corporate profits are headed? I do not mean to be crass. If corporate profit plunge the market will rally as money will flow out of corporate bonds and high yield. Then we will get another Fed pump. The buffoon at the helm of the Fed is out of control.
Economically the economy is going to start to slow…. multinationals are slowing and small businesses are hanging on with no visibility. China is going defensive in anticipation of what we all know is coming down the pipe……
Did anyone see this post By James Bianco at The Big Picture today? Quite the coincidence.
Just skip the first ramblings and scroll down to the last couple graphs. They overlay the deficits with capital gains.
Bianco seems to imply that the drop in capital gains leads to an increase in deficits, while I would argue from the MMR/MMT perspective that the relationship works in the other direction. The deficit drives up profits, which drive up capital gains.
http://www.ritholtz.com/blog/2012/03/blame-the-loss-of-capital-gains-for-the-deficit/
I left a comment there linking back to this post, but it is awaiting approval.
To agree with the mean reversion in the government sector, doesn’t one have to assume that net investment would mean revert as well (go up)? These would offset and voila. Also, he seems to assume that the current account isn’t ever going to improve. I have seen good arguments that shale gas will significantly reduce the need for imported oil over time. Energy is a significant portion of our current account deficit.
JC, i’ve had similiar thoughts as far as the shale gas comment. if i were king for a day, i’d find a way to incent investment in NG as a transportation fuel. odd to me that the private sector can’t get over the hump with such a large differential in oil/gas prices right now
The risk is that investment will grow more slowly than the rate of contraction in the deficit. That’s the big risk right now and into 2013. If the CBO is right and the budget falls to 4% of GDP then investment will likely not pick up the slack and we’ll be in for a dip in profits….
Excellent Kalecki profit equation post! This is meat for the MMR-Based traders!
© 2009 pragcap.com · Register for PC
Yesterday’s post by James Montier did much of the heavy lifting on the corporate profit outlook, but I wanted to add a few details to the future outlook since I run a profit model based on similar thinking. We use the Kalecki profit equation to arrive at an approximation of future profits. I’ll save the mundane accounting details for another day, but the basics are rather simple as Montier outlines:
Pro?ts = Investment "“ Household Savings "“ Government Savings "“ Foreign Savings + Dividends
If you’re really looking for a detail outline here I would highly recommend this piece at the Levy Institute.
What you’ll notice in Montier’s work is that private investment is usually the driver of corporate profits. But these aren’t normal times. The effects of the balance sheet recession are still very much with us and the recovery is proving painfully slow. While private investment is improving it remains well below historical levels of 7.5% of GDP. The good news is that mean reversion is working in our favor and the current level of 4% of GDP is likely to continue climbing. Unfortunately, we’re coming off of very low levels and corporations remain cautious in their approach to the economy.
The key takeaway from the Montier piece is that corporate profits have been largely driven by budget deficits in recent years. This has been the single most important understanding of the balance sheet recession. If you understood that large budget deficits would help offset the de-leveraging process then you had a huge advantage over those who thought we were in for one sustained depression. Unfortunately, the risks are mounting in this regard and corporate profits are at the top of the list.
As both Montier and Richard Bernstein have recently noted, the outlook for profits is looking tepid at best. I’ve run two scenarios through my profit model. The first scenario assumes continued mean reversion in private investment, growth in dividends, flat household saving, marginally deteriorating current account and the CBO’s current 2013 deficit outlook. It’s a very reasonable outlook although I’d argue that there is likely upside in the deficit since I believe politicians are likely to continue many of the current policies as the economy remains weak. In the second scenario I’ve assumed more modest cuts in the deficit, a stronger investment boom, flat household saving, flat current account and modest dividend growth. This, in my opinion, is a more likely outcome. The results follow:
The key point here is that without a big debt boom and an enormous and probably historic investment boom the corporate profits picture is likely to come under more pressure as we head into 2013. And if the budget cuts are sharper than expected we can expect a substantial hit to corporate profits. Stay tuned. Budget updates will continue to play heavily into this outlook as the year plays out….
I wonder if anyone has written a spreadsheet to model future corporate profits, in which one could play with various assumptions, which they would allow the public to download and use?
Does it really matter anymore where corporate profits are headed? I do not mean to be crass. If corporate profit plunge the market will rally as money will flow out of corporate bonds and high yield. Then we will get another Fed pump. The buffoon at the helm of the Fed is out of control.
Economically the economy is going to start to slow…. multinationals are slowing and small businesses are hanging on with no visibility. China is going defensive in anticipation of what we all know is coming down the pipe……
Did anyone see this post By James Bianco at The Big Picture today? Quite the coincidence.
Just skip the first ramblings and scroll down to the last couple graphs. They overlay the deficits with capital gains.
Bianco seems to imply that the drop in capital gains leads to an increase in deficits, while I would argue from the MMR/MMT perspective that the relationship works in the other direction. The deficit drives up profits, which drive up capital gains.
http://www.ritholtz.com/blog/2012/03/blame-the-loss-of-capital-gains-for-the-deficit/
I left a comment there linking back to this post, but it is awaiting approval.
To agree with the mean reversion in the government sector, doesn’t one have to assume that net investment would mean revert as well (go up)? These would offset and voila. Also, he seems to assume that the current account isn’t ever going to improve. I have seen good arguments that shale gas will significantly reduce the need for imported oil over time. Energy is a significant portion of our current account deficit.
JC, i’ve had similiar thoughts as far as the shale gas comment. if i were king for a day, i’d find a way to incent investment in NG as a transportation fuel. odd to me that the private sector can’t get over the hump with such a large differential in oil/gas prices right now
The risk is that investment will grow more slowly than the rate of contraction in the deficit. That’s the big risk right now and into 2013. If the CBO is right and the budget falls to 4% of GDP then investment will likely not pick up the slack and we’ll be in for a dip in profits….
Excellent Kalecki profit equation post! This is meat for the MMR-Based traders!
© 2009 pragcap.com · Register for PC
Yesterday’s post by James Montier did much of the heavy lifting on the corporate profit outlook, but I wanted to add a few details to the future outlook since I run a profit model based on similar thinking. We use the Kalecki profit equation to arrive at an approximation of future profits. I’ll save the mundane accounting details for another day, but the basics are rather simple as Montier outlines:
Pro?ts = Investment "“ Household Savings "“ Government Savings "“ Foreign Savings + Dividends
If you’re really looking for a detail outline here I would highly recommend this piece at the Levy Institute.
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