Yesterday’s post by James Montier did much of the heavy lifting on the corporate profit outlook, but I wanted to add a few details to the future outlook since I run a profit model based on similar thinking.  We use the Kalecki profit equation to arrive at an approximation of future profits.  I’ll save the mundane accounting details for another day, but the basics are rather simple as Montier outlines:

Profits = Investment – Household Savings – Government Savings – Foreign Savings + Dividends

If you’re really looking for a detail outline here I would highly recommend this piece at the Levy Institute.

What you’ll notice in Montier’s work is that private investment is usually the driver of corporate profits.  But these aren’t normal times. The effects of the balance sheet recession are still very much with us and the recovery is proving painfully slow.  While private investment is improving it remains well below historical levels of 7.5% of GDP.  The good news is that mean reversion is working in our favor and the current level of 4% of GDP is likely to continue climbing.  Unfortunately, we’re coming off of very low levels and corporations remain cautious in their approach to the economy.

The key takeaway from the Montier piece is that corporate profits have been largely driven by budget deficits in recent years.  This has been the single most important understanding of the balance sheet recession.  If you understood that large budget deficits would help offset the de-leveraging process then you had a huge advantage over those who thought we were in for one sustained depression.  Unfortunately, the risks are mounting in this regard and corporate profits are at the top of the list.

As both Montier and Richard Bernstein have recently noted, the outlook for profits is looking tepid at best.  I’ve run two scenarios through my profit model.  The first scenario assumes continued mean reversion in private investment, growth in dividends, flat household saving, marginally deteriorating current account and the CBO’s current 2013 deficit outlook.  It’s a very reasonable outlook although I’d argue that there is likely upside in the deficit since I believe politicians are likely to continue many of the current policies as the economy remains weak.  In the second scenario I’ve assumed more modest cuts in the deficit, a stronger investment boom, flat household saving, flat current account and modest dividend growth.  This, in my opinion, is a more likely outcome.  The results follow:

(Low to mid single digit profits growth looks to be on the horizon)

The key point here is that without a big debt boom and an enormous and probably historic investment boom the corporate profits picture is likely to come under more pressure as we head into 2013.  And if the budget cuts are sharper than expected we can expect a substantial hit to corporate profits.  Stay tuned.  Budget updates will continue to play heavily into this outlook as the year plays out….


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.

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  • Optimist

    I wonder if anyone has written a spreadsheet to model future corporate profits, in which one could play with various assumptions, which they would allow the public to download and use?

  • Coolidge Low

    Does it really matter anymore where corporate profits are headed? I do not mean to be crass. If corporate profit plunge the market will rally as money will flow out of corporate bonds and high yield. Then we will get another Fed pump. The buffoon at the helm of the Fed is out of control.

    Economically the economy is going to start to slow…. multinationals are slowing and small businesses are hanging on with no visibility. China is going defensive in anticipation of what we all know is coming down the pipe……

  • jaymaster

    Did anyone see this post By James Bianco at The Big Picture today? Quite the coincidence.

    Just skip the first ramblings and scroll down to the last couple graphs. They overlay the deficits with capital gains.

    Bianco seems to imply that the drop in capital gains leads to an increase in deficits, while I would argue from the MMR/MMT perspective that the relationship works in the other direction. The deficit drives up profits, which drive up capital gains.


    I left a comment there linking back to this post, but it is awaiting approval.

  • JC

    To agree with the mean reversion in the government sector, doesn’t one have to assume that net investment would mean revert as well (go up)? These would offset and voila. Also, he seems to assume that the current account isn’t ever going to improve. I have seen good arguments that shale gas will significantly reduce the need for imported oil over time. Energy is a significant portion of our current account deficit.

  • anonymous

    JC, i’ve had similiar thoughts as far as the shale gas comment. if i were king for a day, i’d find a way to incent investment in NG as a transportation fuel. odd to me that the private sector can’t get over the hump with such a large differential in oil/gas prices right now

  • Coolidge Low

    Excellent Kalecki profit equation post! This is meat for the MMR-Based traders!

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

    The risk is that investment will grow more slowly than the rate of contraction in the deficit. That’s the big risk right now and into 2013. If the CBO is right and the budget falls to 4% of GDP then investment will likely not pick up the slack and we’ll be in for a dip in profits….

  • JC

    I believe the deficit won’t contract as fast as forecast and investment is more likely to mean revert. Maybe the deficit starts to move down, but it won’t get very far before the weakness scares all those that have the power to pull levers. That doesn’t mean there won’t be one heck of a correction in risk assets for a 12-18 month period, but timing is everything. When do you put that trade on? For now I would say you don’t.

  • RozzW

    What this article points out is no surprise at all. I´m a strong supporter of the prof. Stiglitz, who is blaming the corporations and its connections with government, that led to the huge deficits.
    The connection could be seen, when Obama bailed out the big banks (Privatizing Profits, Socializing Losses). Deficits grew bigger and the productive industry stagnates or creates low number of new jobs. The deficit is no problem since US market is protected by the world dependency on its currency. Austerity is the real problem and it will probably produce huge deficits in the near future.

  • Isaac

    Hi Cullen,

    Can you tell me where you’re getting the data for investment? I’m trying to get my data to match up with yours.


  • KB

    Excellent, excellent piece. As I mentioned this many times on this board, commenting on “QE has no effect” meme. Of cause it has no effect! Because deficit does.
    We run deficits, and corporations are the main beneficiaries. And thus, are their shareholders. Who are the loosers? No reason to care about that stuff…
    Regarding Y13 deficit – i plainly believe CBO is lying. There is no way to cut deficits. And because the relationship is not linear – increase in private investments will be inadecuate to compensate for deficit cut, so the government will actually have to increase deficits to maintain the same status quo. Just look what was deficit last time we had similar corporate profits…

  • whatisgoingon

    Great points by all but I haven’t heard the MMT/MMR thinking on this. That is, the MMT/MMR prescription of increasing government spending to offset GDP shortfalls has been effectively been hijacked by corporations as a mechanism to syphon off profits.

    I’m not saying that MMT/MMR is corporate welfare but the way it is being implemented in reality sure makes it look that way.

    Cullen or MMT/MMRer, I’m trying to understand does MMT/MMR view this hijacking of government spending into corporate profits as a real problem? Or do they feel that it the unfortunate cost required to sustain GDP and the larger economy?

  • LRM

    I am a bit excited today after re reading the Mortier white paper and then this post by Cullen. I can actually follow this stuff and have it make sense. As one of my brothers says to me “can you make any money because of this information” I still have to say “NO” but maybe soon!!
    But still, having a new insight into the economy was a nice time investment.

  • innertrader

    Over shadowing ALL of this is the Executive Order that barrack hussein obama signed last Friday… along with the ones he’s been doing over the last 6 months.

  • Old Dog

    Yes Natural Gas usage as a transportation fuel COULD have a material impact on both the current account deficit and the domestic economy – but make no mistake – the current administration is opposed to this in every respect.

    Their entire Global Warming thought process is dependent on making ALL fossil fuels skyrocket in real price. That is what is behind the attacks on fracking. If that attack fails, then they will attack horizontal drilling.

    Their entire Green Energy program is based upon Nat Gas prices moving permanently above $10 / mmbtu.

    Unfortunately for the “The World IS Running Out Of Fossil Fuels” crowd – they forget that capitalism and free markets DO react to scarcity and high prices. Capitalism actually still works exceedingly well when government gets out of the way.

    And eventually capitalism will correct many other economic ills if free markets are allowed to function. But that is looking increasingly unlikely with the current cabal. Big choices with big repercussions this fall boys and girls.

  • Alberto

    “The deficit is no problem since US market is protected by the world dependency on its currency. ”

    This is really the key point because it is the only argument in favor of ever expanding deficits. But I think it’s a faulty reasoning. The fact there are still huge reserves denominated in dollars is not the key point. What’s really important is to understand if the new commercial contracts are signed in dollars or not. And the answer is NO. The use of dollar in new bilateral transactions is decreasing, that is we’re fast going in a world where dollars are requested much less than in the past. So the value of dollar will follow.

  • hangemhi

    Yes, the Global Warming thought process is…. gee, it is friggin hot out here, studies show water levels could overwhelm low lying areas and cause economic disasters, let’s see how we can profit from it…. NOT!

    So now NatGas is the answer? How do you propose this shift will happen? And how, do you figure all of that water needed for fracking, and the threat to acquafirs, will figure into economic projections?

    Note to idealogues… the cheap oil has peaked. Only the expense, dirty, environmentally dangerous stuff remains in abundance. But if you’re a shill for the oil companies, then just keep your head in the (tar) sands

  • hangemhi

    I don’t think anyone has hijacked MMT/MMR. They’ve been increasing the deficit and sending it directly to the bank accounts of the richest since the 1980’s. This is nothing new. As for MMT – they seem to be mostly liberals in favor of deficit spending on things like the job guarantee that has money going directly to people without jobs or money. MMR as far as I can tell doesn’t have one prescription…. Cullen has an interesting innovation initiative, and favors tax cuts.

    Personally (and I am not in any inner circle) I look at the equation “Gov debt = Private Sector savings” and what i see is massive Gov debt and massive savings by billionaires, large corporations, and China/Japan. So if we want to lower the debt, like Willy Sutton said – that’s where the money is. And then new deficit spending must be targeted at those with no money. 65% of Americans have ZERO savings. ZERO. Yet one side of the aisle (who are not hijacking MMT/MMR because they don’t get it – nor do 99% of Americans) are still promoting ideas to enrich the already rich, while cutting programs for the elderly and poor. The problem I see with these proposals is that the rich will take their tax savings and save it – thus ZERO economic benefit, and ever higher deficits. And they will cut spending on those who immediately spend the money – ala food stamps – that money goes right to grocers, truck drivers, farmers and others. So that money produces an economic benefit and is less like to add to the deficit.

    Either way – we need everyone to understand the foundation of MMT/MMR so we can call BS on the rhetoric that is 100% political and 0% economic.

  • Dennis

    I would like to invent a nice and quiet Natural Gas fueled generator that can charge the battery of the electric car that I would like to buy – but can’t afford because electricity is beyond expensive on Maui.

  • Andrea

    It is very interesting, but I am wondering whether the equation is able to capture destroyed wealth wiped out by write off of overvalued assets (for example in the financial sector). Does it matter?
    Thank you in advance for your answer.

  • Hntnfsh4evr

    Cullen, would you be able to provide the NIPA series identifiers used to create the Montier chart which you replicated?

  • Old Dog

    OK Genius!

    Ask any geologist (the only scientific discipline that has access to the real data on Global Climates – The Stratigraphic Record) and you will soon see that the world is actually still in an ice age – presently in an inter-glacial epoch. We still have major ice caps in both hemispheres.

    In normal times there are no ice caps, polar ocean temps approach 70 F and sea levels are approximately 200 feet higher than present. And that condition has existed tens of thousands of times before present – obviously due to Global Warming – but NOT caused by human activities!

    Wake T-F-Up! Get off your Liberal Green BS and realize that the climate is always changing – since day one.

    Blame it all on fossil fuels – please!

    Do you even know what the number one global warming gas is? Not CO2 – nope sorry – it is less than 1/10th of 1%. The number one global warming gas is Water Vapor. But Big Al and his trial lawyer money is jamming junk science into the brains of a lot of unsuspecting people. Without water vapor the world would be an ice ball. The Florida Keys is a Pliestocene carbonate reef formed (12000 years ago) when sea levels were far higher than present. Sea levels will rise – dramatically again even if mankind had never burned one ounce of fossil fuel. Doesn’t anyone look at the REAL data?????

    Yes we need to get off fossil fuels. But lets do it for the right reasons. And in a way that doesn’t make our economy totally uncompetitive with the coal burning pigs of the world (India, China & Europe).

    And yes – all the wonderful sea level cities that exist today will one day be under 100 – 150 feet of sea water again – as those areas have been thousands of times before. Scientific fact.

  • charlesd

    The deficit is not a direct transfer to the “rich” corporations. The deficit spending first shows up as income for the recipient of food stamps, unemployment
    benefits, social security, doctors (in the case of medicare), etc. When these recipients spend their money it ultimately shows up as a corporate revenue.
    Since the corporate sector as a whole did not incur any additional costs related to this revenue, this additional revenue translates into a profit.

  • Jason

    On a related note regarding AGW — a perusal of recent bloomberg news articles will show that Germany and other European countries are taking a big gamble on the order of 100’s of billions of dollars with green energy investment, i.e., wind and solar power, not to mention penalizing fossil fuel plants to the extent that they are shutting down.

    Looking at the numbers on the technical and economic feasibility of these technologies together with my engineering experience, I don’t think its going to work out for them. In fact, it could become downright disasterous. Of course, Japan also has energy problems right now. The energy situation in US is pretty good compared to these other developed countries.