James Montier isn’t on my must read list for no reason.  The latest from the GMO analyst is one of the finer breakdowns of the corporate profit picture I’ve seen a while.  On the back of the Richard Bernstein piece I was beginning to do this exact analysis myself, but it turns out that Montier has done all the heavy lifting for me.  And he’s done it from the exact same approach I was describing.   Montier takes the Kalecki profit equation and breaks down the recent drivers into segments.  He shows that the budget deficit has been the primary driver of corporate profits in recent years:

“With this brief tour of the drivers of macro profi ts complete, we are now in a position to see how the various sources have interacted to generate the profits we have actually witnessed. This decomposition is shown graphically in Exhibit 5. Even a cursory glance at the exhibit reveals that net investment has generally been the biggest driver of corporate profitability over time. However, the stand-out engine of corporate profi ts of late has been the fiscal deficit.”

“To further highlight this dependence of profits upon the fi scal defi cit, Exhibit 6 shows the breakdown of profi ts during 2011. The massive impact that the fiscal defi cit has had becomes immediately clear. Government savings have a negative effect on profits; a fiscal defi cit is just negative government savings, hence the double minus sign in the table below”

And his conclusion:

“The government defi cit may stay high this year, due largely to it being an election year. However, it is almost unthinkable that it will remain at current levels over the course of the next few years. As such, unless households start to re-leverage or the current account improves signifi cantly, and assuming that the government moves toward some form of defi cit reduction plan, corporate profi ts are likely to struggle. From this perspective, a structural break in profi t margins looks to be diffi cult to support. So, for the time being we will continue to base our forecasts on the mean reversion of profit margins.”

That’s really sharp analysis.  If that all sounds familiar then you’ve likely been reading Pragcap because this is precisely the risk I’ve been highlighting in 2013/2014 as the budget deficit is likely to decline and we’re likely to see stagnant economic growth and declining corporate profits.  We’re all clear for 2012, but the risks are plentiful moving forward and if there’s one thing that equity markets hate it’s declining profit margins and profits…..

Source: GMO


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

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.

More Posts - Website

Follow Me:

  • Jay

    Great post

  • http://www.nakedcapitalism.com Philip Pilkington

    Brilliant. Just brilliant.

    Also reinforces my idea that most profits are now accruing through the finance sector. If the finance sector is heavily reliant on inflated commodities prices most of the profits resurgence might be a bubble.


    Might be wrong, of course. I hope I am. But the resurgence in financial profits is unusual given the present environment and clear lack of investment.

  • http://www.nakedcapitalism.com Philip Pilkington

    Am I to understand correctly in thinking that the high level of dividends (higher than historical average) is indicative of a higher level of financial profits?

    Also, I’m confused as to whether the author has allowed for saving out of dividends… the PDF seems to imply that all dividends are spent.

  • http://www.nakedcapitalism.com Philip Pilkington

    Aw crap… now I’m not sure about Montier’s figures. Most sectoral balances that I’ve seen showed households in deficits since at least ’01. Montier’s profits chart has them saving continuously.



  • http://www.pragcap.com Cullen Roche

    I believe he’s just using the personal saving rate which is the household and institutions in the NIPA tables. You can find it here. http://research.stlouisfed.org/fred2/series/PSAVE

    I recreated his chart to a large degree, but I am off by a bit on something…Not sure what though….I can’t seem to get my data to match up perfectly with his. Let me know if you find the right stuff Philip.


  • http://www.pragcap.com Cullen Roche

    Here’s a beauty for you. I estimated corporate profits under the latest CBO estimates for the deficit in ’12 & ’13. I assumed continued improvement in net investment, dividends, etc. The thing moving the needle is the decline in the deficit from 1.1T to 545B taking a healthy cut out of profits in 2013….

  • Anon Jon

    Great read but I find it just slightly lacking. I wish he would have gone further with the reading and discussed how this would impact high & low P/E stocks and maybe included some sensitivity analysis of how different P/E ratios would be affected by a profit margin compression. It seems to me that if you buy a company with say a 6x P/E (say like CLF) would be less impacted than say a company with a 50+ P/E (like AMZN at 140 P/E). But I have no way to quantify what would happen but leaves me hoping this is addressed in the future…

  • Ryan

    Another interesting analysis would be the correlation between years of decreasing Fiscal deficit and treasury yields of different durations. I’m thinking bonds would rally, so depending on how 2012 goes, I’m leaning towards buying the dips in treasuries, and lately municipals.

  • http://www.nakedcapitalism.com Philip Pilkington

    Interesting to see how that matches up.

    I’m still watching the commodities markets like a hawk. I reckon they’re turning over an absolute fortune through hoarding and this is buttressing financial profits to some degree. Impossible to tell, really. But fundamentals are so out of whack across the board…

  • B Ferro

    I’d like to see this for Japanese corporate profits.

  • http://www.nakedcapitalism.com Philip Pilkington

    Can’t understand why Wolf’s et al contradict his. Surely household saving is household saving.

  • AWF

    Exhibit A

    http://www.gmo.com/America/–What goes up must come down–JMontier

    Good reading the first 4 pages–then

    Govrnment Spending = Current driver of Corp profits

    Where does Govrnment spending come from = TAXES on consumers/business

    Consequently/Therefore Less Taxes on consumers and business would also be a driver of Corp profits

    JM states the “History of Corp profits comes from Investment”

    This is the real solution for the US economy

    Corp profit must come from “At Risk” Investments

    For the “Economy” be able to function properly in a historic context we must have Lower Taxes on consumers and business and much Smaller Govrnment spending

    I believe that both sides of the equation

  • http://www.pragcap.com Cullen Roche

    I am not sure either. If you resolve it please let me know. It sure looks like Montier is using the NIPA tables….

  • http://www.nakedcapitalism.com Philip Pilkington

    Something to do with not taking certain types of debt levels into account maybe? Consumer credit? I.e. Credit that doesn’t go into investment. Something like that? I’m clutching at straws…

  • http://www.pragcap.com Cullen Roche

    I think I see what he’s done. He’s taking S-I. Private Saving minus Gross Investment as a % of GDP….

  • http://www.nakedcapitalism.com Philip Pilkington

    Cancelling out household investment? And so putting the housing boom time investment on the ‘investment’ side of the graph. Whereas the sectoral balances graphs count this as household spending?

  • http://www.pragcap.com Cullen Roche

    I actually can’t seem to figure it out. I am not sure what we’re doing wrong….Probably something obvious….

  • http://www.nakedcapitalism.com Philip Pilkington

    Emailed Scott F. He did some sectoral balances at one point. I’ll forward on his response.

  • http://www.pragcap.com Cullen Roche

    Yeah, they’re taking net saving + consumption – domestic investment and dividing by GDP. It’s from the flow of funds data.

  • wh10

    This is awesome. I need to learn me some Kalecki. Would be a good topic for Roche post :).

  • jt26

    Maybe we need higher corporate taxes, because they are clearly not investing with the record profits.

  • whatisgoingon

    GDP = Consumer Spending + Investment + Government Spending + (X-Imports)
    GDP = Wages + Profits + Rents + Interest + (Taxes-Subsidies) on production and import)

    We know the increase in government spending (big government deficits) were used to maintain GDP because the balance sheet recession made it necessary for the deleveraging consumers to cut back on consumer spending.

    But on the income side, where does the the “government spending” go to? I suspect much of it goes to corporate profits (which is great for companies) but how much is ultimately directed to “wages”?

    I hope MMR takes so forethought that there are good checks and measures to ensure government spending is directed to where it is most appropriate (perhaps to increasing real wages and not for corporate welfare).

    It would be good to see where all the “excess government spending” ends up – to real wages or to corporate profits or for subisidies etc.

  • whatisgoingon

    This is what I was alluding to in one of those graphics: profits are increasing and wages are decreasing (as a percentage of national income). I’m not sure I’m behind the idea that government spending is funnelled into corporate profits does not more directly benefit citizens. Actually both are forms of welfare (one is corporate and the other social). I just don’t understand the complete hate some have for any social spending and tolerance others and politicians have for corporate welfare.

  • AWF

    While your making ANOTHER chart of the “Tetons”

    Zero hedge has something to say


  • Gerald P

    All data I have seen show (including inflation) a stagnant or falling wage scale in the US for over a decade.

  • Pierce Inverarity

    “Where does Govrnment spending come from = TAXES on consumers/business”

    No, it doesn’t. Go read Cullen’s primer on the U.S. monetary system please.

  • whatisgoingon

    I saw the same thing. It appears that all this government spending that MMT/MMR want ends up in the hands of the corporations (and not to the citizens themselves in the form of real wages).

    And this is great for stock holders like myself but really is this how things should work. There is room for companies and individuals to both receive the wealth from government spending. I hope MMT or MMR or both try to rectify this.

  • AWG

    “Where does Govrnment spending come from = TAXES on consumers/business”

    No, it doesn’t. Go read Cullen’s primer on the U.S. monetary system please.

    “The Govrnment Spends and then Taxes”

    The statement at its basis is that the Govrnment is All powerfull and can spend without constraint

    I don’t worship at that church- that brings me to “George Carlin”

    You know our Church’s pass around the collection plate every sunday
    George asked Why?–the answer to do “God Work”
    George stated: Isnt “God” all powerfull the Alpha/Omega=the answer=Yes-
    So George “pondered”
    If “God” is all powerfull the Alpha/Omega–why does “God” need money?

    By subsituting the Govrnment for “God”

    I ask –Why does the Govrnment need to TAX

    This brings you to the “Common Good” Define that?

    Here is something for you to read–you must be 18 or older