Picture of the Day: Corporate America Is Back!

"[T]he current earnings target for the S&P 500 for 2011 is higher than actual earnings in 2006, the last full year before the subprime mortgage meltdown. So it doesn't seem at all as if a possible slowdown in global economic growth is factored into the market at all."
-- CNNMoney.com, June 23, 2010

I beg to differ. Consider this chart:

These aren't estimates made by some rosy-eyed kook, mind you. These are actual, in-the-books business profits -- and they're already higher than the previous peak reached in 2006.

Now, these are economy-wide profits, not just S&P 500 profits, so this chart may not be perfectly representative of the stock market. But the trend is obvious: Corporate America is back, and it's more profitable than ever.

While you were sleeping ...
How, you'll ask, did we manage such a ferocious rebound? A few points to consider:

  • Businesses have become phenomenally efficient, as shown by the surge in labor productivity. When productivity rises, companies are extracting more output from each unit of labor. In other words, they're producing the same amount while employing less people. Incredibly, real (inflation-adjusted) GDP is higher today than it was in 2006, even as unemployment more than doubled. This is awful for the jobless, but it's been a godsend for corporate profitability.
  • The earnings crash in 2008 had less to do with falling demand as it did a one-time purge of leveraged financial balance sheets. The magnitude of losses at companies like Citigroup (NYSE: C  ) and AIG (NYSE: AIG  ) didn't reflect the greater economy, yet they were enough to annihilate aggregate profits. Put another way, the crash, not the rebound, was the aberration. That's not saying aggregate profits didn't deserve to fall -- did they ever! Just not to the degree financial profits skewed the big picture in late 2008.
  • Between the zero-percent interest rates, government-subsidized capital, and outrageous accounting leeway, banks have been handed the most generous earnings environment in the history of the universe. As Warren Buffett put it in early 2009: "Banking has never been better in one sense. I mean, the banks are getting their money very cheaply ... spreads have never been wider, all the new business they're doing is terrific." And it was. Goldman Sachs (NYSE: GS  ) couldn't stop making record profits if it tried. And since financial industry makes up 21% of national GDP, their results have a big impact on the aggregates.
  • Businesses have been restocking inventory like champions, which actually accounted for the majority of GDP growth late last year. This, however, is a temporary phenomenon. The profit rebound isn't as impressive when adjusted for inventory valuations, although it still shows current profits rebounding all the way to back to 2006 figures.
  • Profits shown here nominal (not adjusted for inflation), which somewhat explains the record highs. While inflation has been mute lately, it's hasn't exactly been eliminated. The overall consumer price index is roughly 8% higher today than it was in 2006. The sharp rebound in the price of oil that took place in 2009 was a major profit booster for companies like ExxonMobil (NYSE: XOM  ) .
  • Stimulus and other giveaways have without a doubt juiced profits. Cash for Clunkers, for example, was a big (albeit temporary) win for auto manufactures like Ford (NYSE: F  ) and GM. KB Homes (NYSE: KBH  ) , among other homebuilders, was able to turn genuine losses into sizable profits thanks to tweaks of the tax code.

There are other reasons. But these six, in that order, explain most of why profits have rebounded to record highs.

Where to now?
The big questions are whether the current profit highs are sustainable, and if so, what they mean for market valuations.

I have my concerns about the economy, but betting on sustainable profits seems like a fair bet. Corporate leaders have proven that the bottom line won't be sacrificed by anything (including employees), and will do anything short of slave labor to keep profitability intact. That's what they're incentivized to do. True, there's an eventual limit to how much productivity companies can squeeze out. But it's never paid to bet against the flexibility of the U.S. economy. The speed of the profits rebound may have topped, but you have to be certifiably nutcase bearish to expect a substantial drop from here.

As for valuations, that's up for the market to decide. To quote James Grant:

To suppose that the value of a common stock is determined purely by a corporation's earnings ... is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin, and believed Orson Welles when he told them over the radio that the Martians had landed.

There are cheap stocks out there, especially after the recent pullback. Unfortunately, the psychological trauma polluting investors' moods might keep those stocks cheap for a while. Patience is at a premium these days.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Ford Motor is a Motley Fool Stock Advisor selection. The Fool has a disclosure policy.


Read/Post Comments (29) | Recommend This Article (73)

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  • Report this Comment On July 06, 2010, at 4:54 PM, jmcboots wrote:

    There is also the looming and massive tax increases coming in 2011 that corporations are trying to avoid.

    While the profits maybe real, they are no indication of an improving economy. 2011 will reach lower than 2008's lows. As a result confidence in the markets will erode, the markets will collapse and the part II of the recession will commence.

    All because of poor tax policy.

  • Report this Comment On July 06, 2010, at 4:57 PM, DJDynamicNC wrote:

    With real earning power stagnant for over a decade (unless you're in the top 1%) and unemployment still nearly in the double-digit range, keeping the labour market depressed, I think you might fairly say that corporate leaders are willing to do anything, up to and including slave labour, to keep profitability intact.

    Interesting set of priorities, that.

  • Report this Comment On July 06, 2010, at 5:00 PM, DJDynamicNC wrote:

    ^^^ And I agree with JMCBoots about poor tax policy. Restoring our tax rates to levels comparable to those in place during the longest and largest period of sustained prosperity in world history - the decades following World War II - would go a long way towards setting our nation back on the path to fiscal responsibility and world-class infrastructure (the infrastructure that makes all the other achievements possible).

  • Report this Comment On July 06, 2010, at 5:13 PM, boogaloog wrote:

    I don't know, DJDynamicNC ... if you slash taxes on corporations so they can make lots and lots of money, they will grow and hire more and more people just like they're doing now as they make record profits. Oh, wait .....

  • Report this Comment On July 06, 2010, at 5:45 PM, rbraseth wrote:

    With the unemployment at 9.8 percent (plus the other 5 percent we no long bother to count), who is going to be able to buy what corporate America has to sell? If the economy is going to rebound, it will be based on consumer expenditures. That math doesn't work for me. I'm heading to the sidelines.

  • Report this Comment On July 06, 2010, at 5:59 PM, blesto wrote:

    Nice for those corporations. So now, how about some jobs?

  • Report this Comment On July 06, 2010, at 6:16 PM, EarlBingham wrote:

    I think the profits are so high because the corporations aren't hiring. Pretty obvious, that one. So naturally, if the same amount of work (or a little more) is being done, and fewer people are doing it, profits will go up due to reduced labor costs. OK in the short term, but not sustainable forever! I work at a utility company, and they're wearing some folks out with the increased load. I know people from several other industries who are working harder than we are! So corporations need to hire more employees to help balance the load back to where it needs to be. But why should they? With Obamacare looming (they're figuring out right now how expensive that will be) and many of the other foolish policies lurking (cap and trade, etc.) they know that more employees will just exponentially increase costs and decrease profits in the future. We need to restore some kind of fiscal responsibility soon, and let America get back to work!

  • Report this Comment On July 06, 2010, at 6:22 PM, PrincipleOf3rds wrote:

    Lets see....$825 + $1,375 = $2200 Billon

    ...and $2175 billion / 2 = $1100 billion average over the last year, or over $300 billion less than the average from 2006, 2007, and 2008 (pre-melt down).

    This is not indicative of a sweeping recovery; we're merely treading water, before the real melt-down that drowns our hyper-consumer, debt leveraged economy.

  • Report this Comment On July 06, 2010, at 6:42 PM, WyattJunker wrote:

    Corporations will only streamline their operations even more as govt. has made it ever easier to sue them, provide Obama-care for all employees and regulate them.

    I hope corporations hire less and less people. Why would they with this dangerous political ideology? Maybe the government will raise min. wage even more! hahahahahahaha Then watch unemployment go into the low 20's. Genius!

    As far as corporations are concerned, better to learn how to do more with less.

    Thanks to Obama we may have the most underused labor market in 75 years!

  • Report this Comment On July 06, 2010, at 8:43 PM, RonPaul5 wrote:

    Wow, maybe thats because the Fed is flooding the market with dollars. Can't wait till two years from now when we have an even bigger crash because of all the deficit spending.

  • Report this Comment On July 06, 2010, at 9:02 PM, xetn wrote:

    I believe much of the growth in corporate profits is the result of massive layoffs and other cost-cutting actions. But when you have cut to the bone, where do you go from there?

    And then there is the question of what the government will do next to "milk" more out of business to pay for its never-ending spending growth in the false believe that government spending grows the economy. So, while waiting for the next shoe to fall, I believe many companies are in a holding pattern. Witness the growing unemployment.

    How many more companies will follow in the footsteps of Steve Wynn:

    http://blog.mises.org/13170/macau-and-china-is-stable-washin...

  • Report this Comment On July 06, 2010, at 9:15 PM, demodave wrote:

    I saw "Corporate America is Back!" in my inbox and thought, "maybe that's not such a good thing...", so I followed the link.

    "Businesses have become phenomenally efficient" ... "... GDP is higher today than it was in 2006, even as unemployment more than doubled. This is awful for the jobless, but it's been a godsend for corporate profitability."

    Sorry to hack and slash, but this is not just bad for the jobless. It's also not good for the "survivors" of the lay-offs, who end up doing more and more work for less and less pay.

    Those who are advocating for lower taxes and decreased benefits (i.e. fearing "obamacare") are not paying attention to the fact that the money filters higher and higher up to the folks who do less and less work, but rather spend their days around boardroom tables figuring out more and more ways to kill more and more jobs.

    I fully support manufacturing efficiencies (5S, Six Sigma, investment in modern equipment and automation, etc, etc.), but that is not the path that Corporate America is taking in order to increase is short term profits. As much as I wish to be optimistic, I think the short-term profits come at the expense of long-term operations (to say nothing of their profits).

  • Report this Comment On July 06, 2010, at 9:38 PM, xetn wrote:

    Some great "investments" made by your taxpayer-friendly government:

    Here are some random stories that speak volumes about the times we live in.

    The U.S. government is spending 2.6 million tax dollars to study the drinking habits of Chinese prostitutes and another $400,000 to study gay sexual behavior in Argentine bars (yes, bars in Argentina). Link here.

    U.S. officials say that more than $3 billion in cash (much of it aid money paid for by U.S. taxpayers) has been stolen by corrupt officials in Afghanistan and flown out of Kabul International Airport in recent years. Link here.

    Researchers at the State University of New York at Buffalo received $389,000 from the U.S. government to pay 100 residents of Buffalo $45 each to record how much malt liquor they drink and how much pot they smoke each day. Link here.

    It’s reported that a 6-year-old girl from Ohio is on the “no fly” list maintained by U.S. Homeland Security. Link here.

  • Report this Comment On July 06, 2010, at 9:57 PM, Orangejello wrote:

    I would like to echo the majority of everyone else's comments. If corporations are so profitable, why is our unemployment pushing 10%? If this article is factual (which I am sure it is because I have the highest level of respect for TMF) I am very ashamed of our US companies for hoarding profits instead of using it to expand their businesses and providing much needed jobs.

  • Report this Comment On July 06, 2010, at 11:08 PM, demodave wrote:

    XETN,

    It seems that you have a problem with the government supporting academic research. And I am sure that all those studies can easily be made to sound wasteful without any understanding of the work that preceded them or that might follow them.

    It is entirely possible that the research that you describe might lead to helping people recover from addictive behavior, thereby reducing their net cost impact to society. That's a conservative view. From a more liberal perspective, understanding people's problems might help them live better lives.

    Would you care to fix your links so that they actually work, so that those of us who wish to dig deeper can do so?

    Thanks.

  • Report this Comment On July 07, 2010, at 12:19 AM, stills999 wrote:

    The pendulum will swing back. Once [greedy] corporations have laid off everyone they can to squeeze out every penny of profit, what comes next for them? ... they will start hiring again to try to get even more profit!

    We are now paying for banking crisis and deregulation but things will get better again. No need to lower taxes on corporations and transfer more of our wealth to them and make the deficit worse. For proof ... look how Canada raised taxes in the 90s and cut spending ... short-term sacrifice for long term gain!

  • Report this Comment On July 07, 2010, at 1:01 AM, ChrisBern wrote:

    Focusing on this article purely from an investing standpoint, the author brought up a point towards the end that shouldn't be overlooked. Valuation is an entirely different matter from profitability. Robert Schiller's earnings-smoothed PE10 ratio stands today at 19.99. In 2006 it averaged around 26. Other than a few exuberant periods in the past century, most notably 1929, 1966, 2000 and 2005, the ratio was WELL below 26, and almost always below today's 19.99, too.

    Given the headwinds in the economic picture not only in the U.S. but internationally, I'm betting that in the next few years, this PE10 ratio will decline to somewhere between 10 and 14, and stay in that type of a low range for several years thereafter as the severe debt deleveraging continues to unravel. If I'm right that valuations will trend lower, then even rising profits as indicated by the first part of the article would be lucky to yield a break-even S&P 500.

    Bottom line--it's hard for me to envision a significant U.S. stock market boom in the next few years, while it's pretty easy to see a potential sideways or double-dip-drop market. So as far as American equities go, I'm on the sidelines for now.

  • Report this Comment On July 07, 2010, at 1:33 AM, milleniumfalcon wrote:

    All I want to know (as someone who has no job at the moment) is where are the Effing jobs!?

  • Report this Comment On July 07, 2010, at 9:35 AM, LegalizeMe wrote:

    Corporations are taking profits this year under the lower tax rates. Next years earnings/profit is going to fall through the floor. You heard it here first.

  • Report this Comment On July 07, 2010, at 10:29 AM, Darwood11 wrote:

    Business will extract as much efficiency as it can in lean times. At some point, demand exceeds production capacity or capability and at that time, business will expand capacity, add labor or whatever. Office rental space has dropped to about 1993 levels. That's another indicator of unemployment.

    Until such time as demand exceeds capacity, all businesses, both large and small, will not hire. it's that simple.

    Here's my opinion. The reason the banks are super profitable is because our government handed them windfall profits. The reason the banking collapse occurred was because government policy promoted fannie and freddie. The reason we have such high unemployment today is because government policy is to promote political agendas first and in the recent crisis, to take advantage of that crisis to promote those agendas at the sacrifice of job creation. We all recall political push in the 90's to a "service economy". Businessmen aren't stupid. If manufacturing is politically shunned, it behooves one to move into another line of work or to another business, and we have. Or at least, the millions who can. They got finance, business and legal degrees. They moved from manufacturing to construction and now are on the bread lines.

    The recent health care reform and crippled banking bill will not create jobs. In fact, if the 1099 reporting requirements stand, they will penalize me, a small businessman and add to my costs. Further, penalizing savers and retirees with super low interest rates will not promote spending and therefore will not create jobs. Promoting "immigrants" which is a code word for illegal aliens will not create jobs, but will create votes.

    The Obama administration just gave each senior $250 to fill the "donut" in the Medicare payments. That amount is about 33% of NASA's budget. Will that create jobs? No, it won't. Most of that money will be saved or spent on drugs.

    Talk is cheap.

  • Report this Comment On July 07, 2010, at 12:52 PM, mpendragon wrote:

    They cut wages and benefits which increased the productivity of their workforce. We'll get another recovery in which only the especially wealthy really make any ground and the right wing pundits will still scream socialism.

  • Report this Comment On July 07, 2010, at 8:43 PM, MyDonkey wrote:

    The last time we had full employment was in the pioneer days when practically everything was made by hand and everyone worked from dawn to dusk just to survive. The more automated our society becomes, the less work there is for people to do. It's not a conspiracy; it's the natural consequence of having machines and computers do our work for us. We WANT to spend less time working because that leaves us more "spare time" for leisure activities. If we're looking to blame something for unemployment, blame Modern Living.

    Think of all the jobs that have been lost to automation. On top of that, think of the various tasks that people used to perform as part of a paying job, but now we do ourselves: fill our own fuel tanks and pay at the pump (goodbye gas jockeys & clerks), use ATMs and do banking online (goodbye bank tellers), book our own flights and print our own tickets & boarding passes (goodbye travel agents and airline check-in staff), record and bag our own purchases at self-checkouts (goodbye cashiers), and shop online (goodbye retail store staff). These types of jobs continue to disappear, and once they're gone, they're not coming back.

  • Report this Comment On July 07, 2010, at 9:24 PM, GlobalRover wrote:

    Morgan, I beg to differ. Your graph shows Corporate America battening down the hatches.

    There are a few other things 'Back' in Corporate America. Dividends, Inventories & CapEx.

    The Bureau of Economic Analysis reports US Personal Dividend Income reducing by -$8.9bn in Q1 '10 making a full year -$56.9bn clawback from private investors' pockets.

    Total Dividends were down -$27.3bn.

    Inventories down -$36.4bn.

    Capital Consumption down -$226.2bn, banking depreciation rather than investing it.

    You can only guess at the real R&D and Advertising investment picture.

    This is prudent cash management since Banks won't lend to each other let alone customers. As survival of the Corporation is a CEO's prime objective, they are building rainy day protection.

    Hardly a sunny investment outlook.

  • Report this Comment On July 08, 2010, at 10:40 AM, EvilPhD wrote:

    I agree with some of the above that this current skeleton crew is going to become worn down pretty fast. Then again look at China and how they enslave their workers.

    As far as NEW jobs go - you will only see this grow if NEW markets emerge from NEW technologies. That will only come if we stop throwing away money in war and failed companies and start truly investing into some R&D and science.

    As for all the Obama/Hillary/Socialist/Chicken little- care gripes - Make health care like car insurance. This will take the burden off employers, force insurance companies to compete, and lower costs.

    You have to admit that a good chunk of these profits come from jobless people's unemployment checks, which is a "socialist" policy. The fact that a lot of those people are not getting an extension means that the money flow is going to slow down.

    Another fact that many ignore is that for years corporate America has been bleeding jobs to foreign countries, and along with those jobs goes our GDP and our tax revenue never to be seen in America again.

    Big oil companies are spending their R&D money on how to drill deeper to get to that next well when they can take a perfectly good lesson from Brazil and use that money to make oil products from agriculture. One would think less risk, good for the environment, no catastrophic destruction. Just some genetically modified plants. It's that arrogance in the industry full of "college educated" morons that prevents the next step.

    This is another rally cry for stimulus money to go into new forms of energy and technology. Build it and the jobs will come.

  • Report this Comment On July 08, 2010, at 10:52 PM, pkluck wrote:

    At stills999, please don't use Canada as a model we should emulate "look how Canada raised taxes in the 90s and cut spending ... short-term sacrifice for long term gain" 95% of that country doesn't have two nickels to rub together. And people who are really sick and have money come to the USA for treatment, we do not want to emulate them in any manner.

  • Report this Comment On July 09, 2010, at 8:08 PM, QualityPicks wrote:

    Wow, is nobody impressed? Anyone with positive comments? Well, I'm not going to ruin everybody's mood :)

    If profits are higher, why isn't the stock market at new highs? If you tell me that it is because investors are scared, I will say boloney. The only reason the market is not making new all-time highs with the level of profits is because investors "know" about the quality of the profits. If you didn't noticed, the US Government didn't "adjust" and became more efficient during the recession. Au-contraire, they went close to 2 trillion more in debt than before. That means, they kept everybody employed, they kept buying machines, computers, software, services, etc.

    Not only that, but thanks to the Fed and the Government financial companies are profiting like never before. So the profits are "real", but fabricated by the government like we had never seen before.

    The sad part to me is, that the government is can seem to be able to extend this non-sense for much much longer than I believed it was possible. It seems I will die first, before this blows up if ever. Whenever I believe they are out of options they come up with even more ridiculous and unfair options. And nobody can stop them. Republicans and democrats alike, they are almost the same.

  • Report this Comment On July 09, 2010, at 8:14 PM, QualityPicks wrote:

    So in summary, we are 2 trillion more in debt, so that companies can have 100 billion more in profits. Nice!

  • Report this Comment On July 09, 2010, at 10:58 PM, buildakicker wrote:

    The government interest is corporate interest, not people interest... ie unemployment. I have been reading up on New Zealand lately and what their economy is going through... I like it. Here is a good piece on farming: http://www.cato.org/pub_display.php?pub_id=10672

    I really read into things before investing and I am very thankful for TMF. I love the Stock Advisor. Small companies to the max!

  • Report this Comment On July 13, 2010, at 8:18 PM, Sleddawg63 wrote:

    This is the new reality folks. Reading "The World Is Flat" and it predicts that unskilled jobs are gone..mainly to kids in India and China. This has been happening for years, but it has taken this recession to actually to bring the dirty little secret out. The stimulus should have spent more on retraining for a changing world instead of throwing money down a hole.

    Wait til corporate America realizes it can do even better by letting employees work from home while saving on expensive office space.

    Change is afoot.

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