April 6, 2005
Lost in the concerns about the dollar, oil prices, and
inflationary fears has been the spectacular performance of corporate profits
during this economic rebound. The
fourth quarter revision to GDP showed no change in the inflation adjusted
growth of the economy, but a modest gain in price increases.
In the back tables of that release, tables show that
labor costs embedded in a unit of production did not rise. While some higher costs of imports accounted for some price
pressures, this was offset by little change in the interest needed to
finance a unit of production along with an actual reduction in the amount of
capital exhausted in the production of each unit of output.
If prices are rising, but labor and nonlabor costs
other than those related to imports are stable or falling by more than
import costs are rising, then profits must be increasing for each unit of
production. Even after an
increase in the taxes paid per unit of production, operating profits reached
9.1 cents for every dollar of production.
This is among the highest after tax operating profits per unit of
production ever recorded in the United States.
Some of these profit gains are directly related to high
energy costs. In 2002, profits
from domestic petroleum and coal products were $4 billion. In the fourth quarter of 2004, profits in that sector were a
staggering $42.5 billion. They
almost certainly rose significantly higher during the first quarter of this
Not surprisingly, the higher petroleum costs
significantly impacted profits from chemical products.
From $17.1 billion in 2002, those chemical profits had sagged to $8.4
billion by the end of 2004.
All other nondurables, including the paper, food
processing, tobacco, and hard pressed textiles and apparel experienced much
more modest profit gains over this period.
Now that apparel quotas are suspended from China, the apparel and
textile industries are announcing plant closings almost daily.
Thus, profits are not likely to improve there.
If America is losing its manufacturing prowess, as some
claim, then the surge in profits for durable manufacturing is hard to
explain. In 2002, the industry
was still reeling from the recession with losses of $8.3 billion.
In the fourth quarter of 2004, not only had the losses been erased,
but profits jumped to $48.1 billion. Metals,
appliances, and autos all contributed to that improvement.
The stalled sales in previously very profitable SUVs
may end the gains in autos but other durables appear to remain highly
profitable during the winter.
Even with higher energy costs and relatively mild
weather in most parts of the U.S., the utility industry also has recorded
large profit gains in recent quarters.
Not only is American production rising, but the growth is very
Nevertheless, the high energy prices are impacting some
previously strong industries. For
example, transportation and warehousing experienced a surge in profits to
$15.5 billion last spring. Since
then profits have plunged to $4.5 billion.
I would be surprised if any profits are earned in this sector during
The distribution of goods associated with wholesale and
retail trade has experienced little profit growth in the past two years.
We probably have too many stores for the current growth in consumer
activity. While wholesale trade
has fared better, profits there also appear to be stalling.
The information economy, which includes communications
from the wired phones to the wireless communications devices and the
internet purveyors saw a significant dip in profits during the fall.
However, this followed two very profitable quarters that reversed
losses in the previous two years.
Surprisingly, the surge in profits was not apparent in
those earning abroad. While
those profits are up from two years ago, profits from the rest of the world
showed no growth in the fourth quarter and actually remained sharply below
previous year levels.
Those rising insurance premiums and finance charges
also have done little for profits in the financial sector. Profits are growing in these industries (at least after
subtracting the huge hit to capital that insurance companies suffered in the
summer because of hurricanes), but the gains are only slightly over 3
percent in the past year.
In summary, profits continue to grow faster than
economic activity. I believe
operating profits after taxes (and taxes are rising as accelerated
depreciation expires) will grow about 10 percent this year.
Unfortunately, about half those gains will remain concentrated in the
petroleum sector. Nevertheless,
stock values probably do not reflect such continued profit gains.
Indeed, I believe stock values can grow another 8 to 9 percent in the remainder of this year. Then we will see if higher finance costs and some rise in labor costs per unit produced finally begins to erode this enormous recovery in profits of U.S. enterprises.