Sharp Improvement In Corporate Profits In Q2 All But Rules Out Near-Term Recession

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by: New Deal Democrat
Summary

Corporate profits are a long leading indicator, typically turning down one year or more before a recession.

Prior to the 2001 producer-led recession, profits went down about 25%.

At worst, 18 months ago, corporate profits were down less than 20%.

With Q2’s improvement, profits are only down 5% to 10% from their peak.

Considering the state of all long and short leading indicators, the chances of near-term recession are all but ruled out.

Introduction

Corporate profits were released for Q2 yesterday. Since profits adjusted by unit labor costs are a long leading indicator - and the latter was significantly adjusted backdated by five years last week - let's take an updated look.

Profits adjusted by labor costs improved strongly in Q2

Corporate profits, whether measured with or without inventory changes, increased about 5% q/q. Adjusting for an increase in unit labor costs, profits increased between 4% and 4.5%. Here is the long-term look, showing how they have historically turned 1+ years before a recession:

And here is the close-up on this expansion, normed to 100 as of their Q3 2014 peak:

Without inventory adjustment, at their lowest levels since then in Q4 of 2017, profits were down -19%. With inventory adjustment, they were only down -11%.

Compare this with the decline in profits prior to the last producer-led recession in 2001:

The comparative declines were -25% and -29%, respectively.

Before consumer-led recessions, housing permits have typically declined 20% or more from the peak. Before 2001, and this year, housing permits have only declined at most by -12%.

In other words, we don’t have the conditions for a consumer-led recession, and with yesterday’s report, 18 months past the trough in adjusted NIPA profits, they are only -5% to -10% off their peak. Further, as Dean Baker points out this morning, manufacturing and goods production is a considerably smaller part of the economy now than even in 2001.

Had corporate profits declined further, there would have been a worrisome concordance with pre-2001 conditions. Instead, the Q2 corporate profits report dissipates most of the concern from the decline in profits last year.

Comparing corporate profits with the yield curve

One final note: below is the comparison of the YoY% change in adjusted corporate profits with the Treasury yield curve:

In the post-WW2 era, except for 1973, YoY adjusted corporate profits always declined one quarter after the yield curve inversions. Since 1980, the decline has been coincidental. By contrast, at -0.8% for Q2, the decline is virtually non-existent:

Conclusion

Among long leading indicators, right now it is the yield curve which is the odd man out. In addition to the improvement in corporate profits, single family housing permits have improved, real money supply has improved, corporate bond yields have made new lows (a strong positive), and neither real retail sales nor credit provision has ever turned meaningfully negative.

Further, although it is beyond the scope of this post, the short leading indicators of manufacturers' new orders, consumer spending on durable goods, and the average of the regional Fed new orders indexes have all improved as of their reports this week.

The chances of a recession (vs. a slowdown) in the next three to six months are rapidly receding.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.