Originally published March 27, 2008
This morning's release of the fourth quarter corporate profits data underscores the argument we've been making for some time now: profitability peaked in in 2005, and has been heading down since 2006. A graph of this series, pre- and after-tax:
When we do our regular quarterly analysis of the Fed's flow of funds data, NIPA profits are not yet available. But we've found that a measure of profitability for nonfinancial corporations, which divides the NIPA profits figures by the flow of funds measure of the tangible capital stock, has proved an excellent long-term measure of the health of the economy. For example, profitability peaked in 1966 and began a long slide, before bottoming out in 1982. This coincided with the onset of the stagflationary economy of the 1970s, which was reflected in poor financial market performance. Profitability rose from 1982 through 1997, a period marked by strong stock and bond markets - some of the strongest in American economic history. Profitability took a five-year dive into late 2001, when it began a strong recovery, gaining back about three-quarters of what it lost in the decline. But over the last two years, profitability has given back about half that gain.
(Those are based on pretax numbers. The 2001-5 recovery in after-tax profitability was somewhat less impressive, and the decline since 2005 has been sharper, than the pretax measure.)
We emphasize that this profitability measure is a long-term one; it's not something to trade off. But its course over the last two years suggests that the U.S. economy is facing some serious structural headwinds that could make financial market performance unpleasant in the coming years.
- Philippa Dunne & Doug Henwood