A Nasty Surprise In Corporate Profits

A Nasty Surprise In Corporate Profits
New York City at night.

This morning, the Bureau of Economic Analysis released a shocking report on the current state of American Business. Buried within this morning's report on the Nation's GDP was the report on Corporate Profits for Q1 2024. Today's report was the preliminary report on Profits, and next month's report will have a final revision.

However, the scope of today's report is sufficient to give a good insight into how Corporate America is performing. American businesses operate in two very different worlds. On the one hand, the financial companies are doing quite well, thank you. Profits for Financials increased by a substantial $73 billion for the quarter, thanks to that roaring bull market we're experiencing.

That $73 Billion increase helped hide the stunning $114 billion drop in non-financial profits. Put another way, things have turned dire if you're operating anywhere except Wall Street. This nearly 5% drop in non-financial profits does not bode well for the economy.

Here's the rub: Corporate Profits are perhaps the single most important indicator for the direction of the stock market. Most analysts would agree that profits are the real driver behind Bull Markets. Without getting overly technical, investors generally look for rising profits as a key element in their asset allocation. Investors generally purchase stocks with rising profits while moving away from stocks with declining profits.

Nvidia is a classic example of the power of rising earnings/profits. The recent spectacular price performance of Nvidia stock is due, in considerable measure, to its recent earnings. Granted, some of its current performance is due to future expectations for the company, but those expectations rely on continued positive profits/earnings growth.

Today's Corporate Profits report shows how difficult it is for non-financial companies to maintain their profit growth. The further a company is from the intersection of Broad and Wall Street, the more difficult it is to sustain its profits.

This is consistent with the Q1 2024 GDP report. This second estimate of GDP Growth was revised lower by .3%. While that may not sound like much, the BEA now reports that the economy is only growing 1.3%. That's a 60% reduction in the growth rate of the quarter before (Q4 2023). The economy is braking sharply.

The current report (Q1 2024) falls just 24 months after the Federal Reserve began hiking interest rates in Q1 2022. You'll recall that this action by the Fed was aimed at curtailing inflation. However, such monetary tightening always carries with it a lag period. Generally, it takes 18 to 30 months to tighten/raise interest rates to impact the economy. We're on that glide path currently. No matter what the Fed does this summer, we expect the economy to continue to slow, and that slowing will continue to be reflected in Corporate Profits.

If Non-Financial Corporate Profits continue to decline, and history is our guide, then the current Bull phase in equities should follow suit. Look for Wall Street to fall into lower profits sometime later in the year.

Admittedly, there are many hypotheticals involved in all of this. But if we're even partly on the mark, then the political implications for all of this are tremendous. A declining economy and potentially a declining stock market at just the time that people consider for whom to vote—not a good combination for an incumbent.

In any event, today's report contained two nasty surprises. First, there was a significant drop in non-financial corporate profits, $114 billion lower than the quarter before. Second, this second GDP estimate was reduced by another .3% to a growth rate of just 1.3%. That's pretty close to the economy's stall speed.

We'll stay tuned for next month's update, but it appears that things are starting to slow rapidly.

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Jamie Larson