by G. C. Mays
The third estimate of 1st Quarter GDP showed the U.S. economy growing at an annual rate of 1.9 percent, unchanged from the second estimate. What did change was corporate profits, which fell during the first quarter to $1.980.5 billion from an initial estimate of $1.998.3 billion. This marks the first time corporate profits have declined quarter to quarter since the 4th quarter of 2008 when profits bottomed out at 7.5 percent of GDP at $1.175.2 billion and GDP contracted at an annual rate of -8.9 percent.
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Source: The Mays Report
Does a single contraction in corporate profits signal a recession? Hardly. Corporate profits expressed as a percentage of GDP tumbled lower in 5 of 6 quarters leading to the recession that begin in the first quarter of 2008. Especially since the profits of U.S. corporations are no longer correlated to with domestic GDP growth. As I wrote last year in an article entitled, "The Relationship Between Corporate Profits and U.S. GDP Growth Appears to Have Ended", between Q1 2006 - Q1 2011 corporate profits only explain 10.1 percent of GDP growth.
American multinationals operating in the eurozone are fighting slack demand as well as a weaker Euro that erodes their revenues and net income. Technically, revenues and expenses are translated at the exchange rate that existed when the transaction took place. However, for practical reasons the average exchange rate over the reporting period is often used to translate most income statement items. There are more specific accounting rules related to translating certain expenses related to fixed assets depending on the translation method used. We are going to ignore these specifics for the sake of simplicity, as we focus on revenues only.
For example, in Q1 of 2012 Ford Motor Company (F) revenues from eurozone countries tumbled 17.3 percent to $7.2 billion. While weak demand clearly lowered gross revenues in the local currency and accounted for roughly 14 percent of the decline, around 4 percent of the decline was due to a stronger U.S. dollar as the average EUR/USD exchange rate fell from $1.3667 in Q1 2011 to $1.3106 in Q1 2012.
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Source: The Mays Report
Ford Motor company's $23.9 billion in 2011 eurozone sales represent about 18 percent of the company's $136.2 billion in total revenues. However, companies like McDonald's (MCD), Philip Morris (PM), and Apple (AAPL) have even more exposure. In the first quarter of 2012 McDonald's, Philip Morris, and Apple revenues from Europe represented 38%, 23%, and 23% of company revenues, respectively.
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Source: The Mays Report
Taking a preliminary look at what second quarter GDP may look like, nominal personal consumption expenditures on both durable and non-durable goods were down in April and May, while expenditures on services rose 0.3 percent in both months.
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Source: The Mays Report
The annualized increase in real personal consumption over the first two months of the 2nd quarter equals about 1.0 percent. Given that consumption accounts for roughly 70 percent of U.S. gross domestic product, I estimate an even more anemic annual growth rate of roughly 1.5 percent during the 2nd quarter with a range of 1.3 to 1.7 percent. Consensus estimates are for about 2.0 percent growth. With the EUR/USD exchange rate averaging $1.2847 and heightened uncertainty in Europe during most of Q2, I expect the profits of U.S. multinationals to fall again.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
