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Friday, August 29, 2014

A look at Q2 profit data

Today's GDP update also contained a look at corporate profits.  Here is a look at the change.

It is now showing Q1's drop was 16% (that was revised lower from the May report).  The rebound in Q2 was reported at 8.3%.  That sounds pretty good until we look at it on a year over year basis.

The year over year change was -9%.  Not a very pretty number.  The BEA numbers include public and private companies so it is a very broad measure of profits.  In theory it should tell us more about the underlying U.S. economy then just the numbers from public companies.  I believe many public companies massage earnings a lot.  This less massaged data probably gives us good reason for why we have seen so much M&A activity this year.  It is the usual response when organic revenue and profit growth declines.  It probably also explains the big surge in stock buybacks in Q1. Will the profit picture pick up over the next few quarters?  1998 is the only time we had a decline in profits like this that was not associated with a recession.  However, we had much stronger economic growth at that time then we have now.  Here is a GDP chart that shows how much stronger the economy was then.

The weakest quarter we had in 1998 was Q2 at 3.9%. Q3 and Q4 were 5.3 and 6.7% respectively.  I don't know the reason for the big drop in  profits that year.  It does not appear to have been economic weakness.  However, we can't say that this time.  Q1 was definitely weak.  While the current data shows a strong rebound in Q2 we don't have all the revisions yet.  One factor I am sure affected Q2 was a the Windows XP upgrade cycle as support was discontinued in April.  That upgrade was big enough to cause memory, hard drive and processor company stocks to surge (the so called old tech stocks that were all the rage early this year).  That cycle was probably largely completed in that quarter.  Certainly by Q3 so I don't think we can count on that being much of a positive factor going forward.

While the retail ETF RTH recently broke out to new highs there are a lot of retailers doing poorly on their earnings.  Even high end retailers M, JWN, and DDS were knocked down hard on earnings.  JWN and M came roaring back after the smackdown, but the fact remains their earnings were not particularly good.  That would not seem to make sense if the economy is truly as strong as the pundits would have us believe.  It would make sense if the consumer truly is weak and the strength was largely the XP computer upgrade.  The economic picture seems cloudy to me and is not being helped by weakness in Europe, Japan, and China.  It will be interesting to see how the revisions play out.


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