BERNSTEIN: BEWARE THE PROFIT RECESSION

One of the better market calls I’ve seen over the last 10 years was Richard Bernstein and David Rosenberg teaming up near the peak of the housing bubble to call for a profit recession and a full blown recession.  At the time, both were Merrill analysts and I was a daily reader of their research.  Bernstein was the equity guy and Rosenberg was the chief economist and they made one of the better Wall Street research duos around.  They didn’t always agree, but in this case they did.  And boy were they right.

In his latest note Richard Bernstein is growing increasingly concerned about corporate profits.  He says:

“The US corporate profits story, however, is showing the first chink in the armor. The proportion of US companies reporting negative earnings surprises has jumped significantly so far in the current reporting period. With over half of the S&P 500 companies reported, 30% of the companies have reported negative earnings surprises. If reports continued in the same pattern for the remainder of the reporting season, the current reporting period would be the worst since 2008.

It seems increasingly clear that the profits cycle is slowing enough so that one should again consider the probability, albeit still reasonably low, of a profits recession. We are not suggesting that a profits recession is imminent. Rather, we are simply saying that the profits data appears for the first time in this cycle to be weakening enough to warrant consideration of such an outcome.”

I’d echo Bernstein’s note, but with a bit more specificity.  We’ve seen a substantial increase in corporate profits in recent years thanks in large part to the gigantic federal budget deficit.  We know from Kalecki’s work that budget deficits are a primary driver of profits.  And in this cycle that has been particularly pronounced given the balance sheet recession and the weakness in the household sector.   As I’ve noted previously, the odds of recession this year with a near $1 trillion deficit are very low.  I’d say the same is true regarding a profit recession, but as we near 2013 the likelihood of much smaller deficits looms large.  If we go the way of Europe 2013 could turn out to be a double whammy.  Real recession AND profit recession.  Stay tuned.

 

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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Comments

  1. I’ve been looking for a mild profit recession, but not a real recession here.

    Currencies are pretty important right here. The dollar is impacting a lot of multinational companies, many of which are already seeing relative weakness from foreign operations. Productivity gains appear maxed out, and the destocking from 4Q11 has obfuscated 1Q12. It sounds like enough companies are tired of waiting and willing to start long-term capex projects that there could be a profit/GDP divergence because of foreign operations.

  2. I’m compelled to say:

    kalecki work is nothing but crap: ” budget deficits are the primary driver of profits” Some one take that economy please!

    Poor Apple — what would they do without the government?

    When the govrnment takes in too much money in tax – the govrnment should return it to the payers!

    The equations are nonsense–why? Take the govrnment out of the equations– you still have an economy — with corp making profit if there products warrant them

      • “Fix the potholes before we take government away.

        That must be a “shovel ready” project

        “Also arrest criminals first” Which ones?

    • Apple would be poor were it not for the stimulus. Consumers would still be de-leveraging and we’d likely look a lot more like Greece than what we have today. Where do you think all those consumers got their money after all?

      How does a govt “return” money to tax payers? They either spend it into the economy. Or they tax less letting us keep more money they’ve already spent into the economy!

      You can’t “take the government out of the equations”. They’re the currency issuer.

      • You can’t “take the government out of the equations”. They’re the currency issuer.

        Nonsense–We have barter/service transctions everyday

        “Kalecki Work” Forcing Math/Algebra on economic ideas is an Insult to math and the math profession–added for Humor–but true none the less

        Where do you think all those consumers got their money after all?

        Surprise,Surprise–there are STILL people with a business and a Job

        Or they tax less ( what a concept!)
        How about a reduction in payroll tax?-I wonder if thats been tried?????? Humm

        letting us keep more money they’ve already spent into the economy!—

        The Chicken or the Egg– Hint–The govrnment is not the chicken

        Lets go back to Econ 101–Where is wealth created?
        Hint,Hint–The govrnment is not the “First Creator” of Wealth

        • But the government IS the creator of the USD needed by our overleveraged domestic household sector to pay down their debt to levels where they feel comfortable enough buying Apple products.

        • Really? How much bartering do you really do? Does it run our economy? No, not even close.

          I’ve proposed a reduction in taxes….

          It’s not really a chicken and egg story. Resources precede taxation. We create the tax and govt to move resources from the pvt to public domain. That’s simple. No chicken. No egg. Just a start and finish. And no one is saying the govt “creates the wealth”. I explain all of this in my primer. Real wealth is created through real production. Govt money is just used to monetize that real wealth and facilitate its expansion….But pretending govt money doesn’t exist is creating an alternate reality. You can dislike govt all you want, but you can’t dislike it out of existence.

          • “I’d echo Bernstein’s note, but with a bit more specificity. We’ve seen a substantial increase in corporate profits in recent years thanks in large part to the gigantic federal budget deficit”

            I disagree with This/Your statement

            • I will repeat: “But the government IS the creator of the USD needed by our overleveraged domestic household sector to pay down their debt to levels where they feel comfortable enough buying Apple products.” The government deficit has ALLOWED the private household domestic sector to delever. Without that delevering process, the demand for Apple products would be reduced. Regardless of how awesome the iPhone 4GS or “new” iPad are, if people don’t have the means to pay for them, they won’t be bought.

              • The working population of the US approx 153 million

                Sale of the New IPAD’s Wordwide = 3 million

                Your “delevering argument” is suspect

                • Demand falls off a cliff for everything but inelastic products (food, heat, shelter) during a delevering cycle unless this delevering is propped up by increased spending by either a) the domestic government b) inflows of cash from abroad. This is really basic stuff that you should take the time to learn.

                  • “Demand falls off a cliff for everything but inelastic products (food, heat, shelter) during a delevering cycle unless this delevering is propped up by increased spending by either a) the domestic government b) inflows of cash from abroad.”

                    You have overlooked the effect of lower TAXES

                    Simply the govrnment can Spend more or Tax less–

                    The 1921 Recession is an example of lower taxes on the economy–
                    “Consumer Demand” responded and the overall economy recovered Quickly

                    Just the Facts–basic stuff

                    More Govrnment spending is not the solution to every problem.

                    • If you reduce taxes and don’t reduce spending, you are effectively increasing the amount of USD coming from the government. As Cullen remarked, no one is calling for higher government spending, per se, but the domestic private household sector MUST get more USD from somewhere in order to lower the debt burden they are under. If you reduce taxes AND reduce spending with our current account deficit, you will not assist the dphs in delevering.

  3. The bears will have there day. It should come soon but it will bee a frustrating one for them once again. Bernstein is right about profits. History supports this. But we should have fewer and fewer leadership in this market until it finally peaks.
    Unfortunatley even if margins do in fact peak if this market gets over 1430 here are the returns we have seen on the SPX. (if SPX > 1430. AFTER a rally > 30% from a low after a >19% decline) The samples go back to 1896(I know kind of ridiculous but we include them anyway because we have them)
    24 are up
    5 are down
    Avg return from 1430 over 12 months is 17.49%
    The largest declines occured in 1930 -29.5% 1931 -35.4% and 1934 -20%. The similarities of the depression and what we experienced in 2008 should not be lost on anyone. NOR should we given Bens proclivity to go all in as well as Europe to go all in should we think this will be repeated.
    The possitive years were 2009 up 29% 1935 up 41% 1932 up 82% and 1904 up 47% with the remaining all clustered aroun 17%
    My point- I agree with Hussmans 7 yr returns. I agree with Shiller CAPE etc. and no doubt we will have our recession at some point. BUT- I like those odds. Further- this market top takes some time to form it could be another 6 months of ROC lower than the px here. However my own view is that come the end of April you’ll see the typical- This has been the greatest start to the mkt in 10 years..should investors sell in may and go away? Then in September you’ll get the investors who sold in may are happy as the mkt has declined 15% or something. Then of course we back fill up to 1550 and we may in fact have our top. Maybe maybe not. Because on Average 17.49 from 1430(if it gets there) is 1680 on the SPX.
    Right now…the market feels like dating a stripper. Every day that passes she gives more and more red flags.
    I wonder what we will see when we look back on this time in 2013. We spend alot of time on the minute rumors and soundbites over the wire. Same amount of time we spent in 2010, 2011 and again in 2012. Everyone is hyper sensitve to the red arrows and non-confirmations we seeing all over the market. But why then if you bought at the high in 2010 and 2011 have you still made money? Only a handful of diversified Mutual funds are still negative from 2007 highs. Most charts I see make all this talk a little silly in the end.
    Now I have and read Russell Napiers- Anatomy of a Bear and many others like it. So none of the Secular bear case is lost on me. I know it better than most.
    Just noticed the VIX and a study I read. Somethings probably coming…but would this get the bears to buy? No- theres never a good time to buy when you think Iran and North Korea will destroy what only God can. Theres neve a good time to buy when since 2009 you’ve been waiting for 1982 valuations and Hussman 7 yr returns of 19% to finally confirm it’s all safe. Think about that. Hussman had 7 yr returns of 10% at the low in 2009 and he balked. couldn’t pull the trigger. even if his accounts went lower from there what is better than 10% returns he knew he would get? There is never a good or safe time to buy stocks. this may be a poor time long term. But what needs to happen for many of you to finally do something?

    • To that-the Bears probably pray at night that Isreal attacks Iran. They won’t admit it…but if I had to bet…the best time to do something is during the Olympics when the worlds attention is focused to London and our politicians are distractdd with elections.

  4. One of the finest pieces I have read lately. A great piece that helped reassure my views and that I am not going crazy.

    http://advisorperspectives.com/newsletters12/pdfs/Bob_Rodriguez_on_the_Dangers_in_Todays_Markets.pdf

    I have a big chunk of cash, a big chunk in low duration fixed income, a smaller chunk In longer duration build America bonds and tips, 7% in TIAACREF RE account, and 5% in turbo charged gold, leaps on GLD, GDX, GDXJ. I have my doubts on gold but I will stay put with the position. As I said I a recent post I am close to -3% YTD due to decline in the price of the gold positions and nimbly trying to short this market. Last but not least I have a 2% equity stake in 4 biotech stocks. Just an experiment on four stocks Mauldin recommended recently. Just a gamble I don’t have much hope it will succeed to see if any of them become a 20 bagger. Just a gamble I don’t have much hope it will succeed. I don’t dare to post the tickers as I know absolutely nothing about these firms..

    • @ Oct-

      FPA Capital has 70%invested in Stocks, 29% in Cash..with 15% invested in Europe
      FPA Crscent has 64%invested in Stocks, 31% in Cash with —-23% invested in Europe
      FPA Paramount has 95% invested in Stocks with 5% Cash
      FPA Perennial is 100% invested in Stocks.

      SO LET ME GET THIS STRAIGHT. This interview with Rodriguez was on FEBRUARY 14th and as of March 1 2012 he is so bearish that his firm allocations are as seen above?
      Do I need to say anything else about how we pick and choose what we want to believe. He’s basically so bearish and worried about the dangers he’s 70% in STOCKS. and in his Moderate Allocation fund he’s 64% which historically is the exact average % every Ibbotson, MPT cookie cutter allocation weighting he should carry.
      Am I missing something? I can view his holdings right now…and theres nothing bearish or risk adverse in his current holdings. He owns the one Bank which failed the weak Bank Stress tests— $30,000,000 worth of Citigroup.

      • A money manager can only deviate so much from the objective of the investment vehicles they offfer. It seems to me cash levels in the order of 30% are very high for an equity fund. Of course, he does not see as much danger as in 2007. The collective wisdom is that ZIRP/central bank liquidity has put a floor on markets is still working; and will work until it doesn’t.

        I don’t have any clients I have to report to so I can be a lot more radical. I got a 12.95% return in 2008. Virtually none of the mainly long professional money managers achieved that. I have to check the prudent bear fund to see how they did. Last year, I clocked 6.96%. Again, not many mainly long managers achieved that. Not even Arnott with PAUIX.

        • Octavio- We’ve been together here a long time. Friends on the TPC if you ask me.
          FPA which if you ask me is one of the finest firm in the world. Rodriguez is top notch. I wanted to point out his holdings. Yes they do seem high but…70% is about what the allocation in any risk profile would call for in a growth allocation.
          I loved the piece especially the part about USC! Fight ON

  5. Profit recession will also coincide with more hiring. One reason why profit margins went up so much compared to the historical average was a return of profits w/o hiring.

  6. Large budget deficit in Australia isnt doing much for corporate profits. I’d imagine currency has a fair bit to do with it

  7. “As Cullen remarked, no one is calling for higher government spending, per se, but the domestic private household sector MUST get more USD from somewhere in order to lower the debt burden they are under.”

    DPHS will get money back from the Govrnment in Reduced Taxes

    After all TAX is our Money–reduced taxes would/could lower DPHS Debt!

    Of course the consumer may not reduce debt–They might buy an IPAD
    and help Corp. America

    So by substitution
    “Whats good for the Consumer is good for Apple”
    “Whats good for Apple is good for Corp America”” and
    “Whats good for Corp America is Good for the Govrnmemt” Humm

    This is way too complicated–this needs the cartoon Bears for explanation