I Need a Hero - Bonnie Tyler
A few of us investment manager types were sitting around this week discussing economics (imagine the geek factor of the Big Bang Theory sitcom, minus the physics and the waitress). Our quandary: corporate profits and the Gross Domestic Product. There is a conflict between corporate profit growth and GDP growth. How is it that we can have the slowest recovery ever and still have strong growth in corporate profits? How have company managers been able to grow profits without growing sales year after year? Can this continue?
A business manager can increase profits by increasing profit margin. He can do this by reducing his costs, or by increasing the price of his goods. In this recovery he has reduced his costs to increase profit. We usually think of this as keeping wages low and sourcing from overseas. Productivity data indicate managers are doing a good job of getting more value for their expenditures.
A business manager can increase profits by increasing sales volume from existing assets. (More taxi rides per car, or more sales per store.) Asset turnover has improved much in this economic recovery, because of sluggish sales growth.
Lastly, a business manager can use leverage either to increase assets or to decrease equity.
Business managers in this cycle have done neither. Instead they have reduced leverage, cut costs and shrunk assets. They did this not only during the recession but in the years that followed.
The Federal Reserve and Congress have tried to stimulate the economy through spending and lower interest rates. Business managers have been thankful for the increased sales and reduced interest expense, but have not felt confident enough to expand, promote and hire.
At some point mangers will begin to be less fearful and more bold. They will believe their prospects are better and they will buy a new truck, open a new store or hire a new worker. These investments will pay off and will be repeated. Then and only then will we enter a virtuous cycle of increased sales, productivity, hiring and profits. The courage comes first.
We are monitoring the Institute for Supply Management surveys for signs of courage.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: © Regions Bank, Member FDIC. The foregoing represents the opinions of the author, Brian Sullivan, and not necessarily those of Regions Bank or Regions Investment Management, Inc. (RIM). RIM provides commentary to clients of Regions Bank, an affiliated company wholly owned by Regions Financial Corporation. The information contained in this report is based on sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be a complete analysis of the security, company or industry involved. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This report is designed to provide commentary on market strategy and the opinions expressed reflect the judgment of the author as of the date of publication and are subject to change without notice. RIM assumes no responsibility or liability for any loss that may directly or indirectly result from the use of such information by you or any other person. Investments discussed in this report are not FDIC-insured, not deposits of Regions Bank or its affiliates, not guaranteed by Regions Bank or its affiliates, not insured by any government agency, and may go down in value. Investment advisory services are offered through RIM, a Registered Investment Adviser. RIM is wholly owned by RFC Financial Services Holding LLC, which in turn, is a wholly owned subsidiary of Regions Financial Corporation.