My friend Jim Smith sent the email message below to the membership of NBEIC, a group of economists of which I have the privilege to be a member. Jim is chief economist of EconForecaster, LLC, in Asheville, NC, and adjunct professor in the Kenan-Flagler Business School of the University of North Carolina, Chapel Hill. Jim has given me permission to send this to our readers and to give out his email address, in case anyone wishes to correspond with him. He can be reached at firstname.lastname@example.org. We wish Jim and you a restful Labor Day weekend and trust you will enjoy this reading.
Jim Smith wrote:
How on earth did the media fail to trumpet the good news from the BEA last Thursday and Friday from the rooftops? If you read The Wall Street Journal, you would never know about the record-breaking results for all measures of corporate profits. You would certainly not realize that, after several previous records that have all been revised away, we finally saw a record for real disposable personal income set in July. That is huge and it should last this time, as the data have been creeping steadily toward this record for some time. What all this means is that when the FOMC meets on September 16 and 17, they will be looking at a US economy in which more people are employed than ever before, earning more money than ever before, producing more goods and services than ever before, and with personal consumption expenditures and corporate profits at the highest levels ever seen. If that is not a prescription for finally raising the Fed Funds rate, then I can’t imagine what it would take to get them to move.
Jim’s full analysis is reproduced below.
Unalloyed Good Economic News
By Jim Smith
Just like the arrival of the cavalry in an old Western movie, the BEA on August 27 gave us economic news on the recent performance of the US economy that was so good it sent the bears, who had been driving down US stock prices with a vengeance for several days, back into hibernation. Rather than the paltry 2.3 percent rise in real GDP at a seasonally adjusted annual rate from the tiny 0.6 percent at a seasonally adjusted annual rate in the first quarter of 2015 previously reported, we learned that the rebound was instead a robust 3.7 percent at a seasonally adjusted annual rate.
As the chart below shows, this was the best growth rate the US economy has demonstrated since the 4.3 percent at a seasonally adjusted annual rate we saw in the third quarter of 2014. Indeed, of the 24 quarters of real GDP data since the end of the last recession in June 2009, last quarter was the seventh best in terms of the growth rate.
Every major sector of the economy contributed to the powerful upward revisions of real GDP. Personal consumption expenditures (PCE) rose at a seasonally adjusted annual rate of 3.1 percent, well above the 1.8 percent at a seasonally adjusted annual rate in the first quarter.
Gross private domestic investment rose by 5.2 percent at a seasonally adjusted annual rate in the second quarter after a robust 8.6 percent pace at a seasonally adjusted annual rate in the first quarter. The revision was a huge improvement over the extremely weak 0.3 percent at a seasonally adjusted annual rate originally reported in the “Advance Estimate” of July 30.
The level of investment in the second quarter of 2015 was $2.9 trillion at a seasonally adjusted annual rate. That was 3.9 percent above a year earlier. This is much more than the year-over-year increase in real GDP (2.7 percent) and suggests that at least some of the concerns about subpar growth in business fixed investment are misplaced.
Exports rose at a seasonally adjusted annual rate of 5.2 percent in the second quarter to a level of $2.1 trillion at a seasonally adjusted annual rate. That was 1.5 percent above a year earlier. In the first quarter of 2015, exports fell at a seasonally adjusted annual rate of 6.0 percent, reflecting the port strikes in Los Angeles and Long Beach and some more severe-than-usual winter weather in other locations that hampered production and shipments.
Imports increased by 2.8 percent at a seasonally adjusted annual rate in the second quarter, a big drop from the 7.1 percent rise at a seasonally adjusted annual rate in the first quarter. This meant that real net exports (exports minus imports) were running at a seasonally adjusted annual rate of $8.5 billion in the second quarter. That was a gargantuan improvement over the negative $77.5 billion at a seasonally adjusted annual rate they subtracted from real GDP in the first quarter.
Government consumption expenditures and gross investment went up at a seasonally adjusted annual rate of 2.6 percent in the second quarter. All of that was due to a 4.3 percent rise at a seasonally adjusted annual rate in spending by state and local governments as most states are experiencing healthy growth in tax revenues. Federal government spending on goods and services was flat in the second quarter, posting a most unusual change of 0.0 percent at a seasonally adjusted annual rate.
The same report from BEA also had encouraging news on corporate profits. The following chart shows the history of after-tax corporate profits excluding inventory valuation and capital consumption allowances (basically, depreciation). Note that the level in the second quarter of 2015 ($1.8 trillion at a seasonally adjusted annual rate) is the highest in history. It was 7.3 percent higher than a year earlier. For some reason that strong increase in after-tax corporate profits was not widely reported.
Record levels of after-tax corporate profits are important for several reasons. The main one is that they mean there is a lot of room for companies to invest more in plant, equipment, software and research and development. Such investments provide a large impetus to economic growth in the future.
A second reason is that higher profits support rising stock prices at the same price-earnings ratio. This had to be reassuring to stock market participants after the wild downs and ups of August 20-26.
Pretax corporate profits on the same basis were also rising at a record level in the second quarter. They hit $2.4 trillion at a seasonally adjusted annual rate.
That was up 6.4 percent from the same quarter of 2014. Pretax corporate profits were 13.2 percent of GDP in the second quarter. After- tax corporate profits were 10.2 percent of the $17.9 trillion GDP, at a seasonally adjusted annual rate, in the second quarter. Most people think corporate profits are a far larger share of GDP than is actually the case.
Likewise, taxes on corporate income hit a new record high in the second quarter at $546.1 billion at a seasonally adjusted annual rate. That was up 3.5 percent from a year earlier.
Another milestone was reached in July. On August 28, BEA gave us data on disposable personal income (DPI), both real and nominal. Real DPI was running at a seasonally adjusted annual rate of $12,216.5 billion.
On August 3, BEA released revised estimates of personal income and personal consumption expenditures all the way back to 1976. In the August 28 release, they revised the data for the first six months of 2015.
As the chart below shows, the result of all these revisions was to restore December 2012 to the record of $12,194.8 billion of real disposable personal income. That was the last month that people earning over $400,000 per year could pull income forward from 2013 to avoid the much higher personal income taxes and Medicare taxes that became effective on January 1, 2013. The US has never seen such a flurry of prepaid bonuses, dividends and other payments before or since.
This astounding record was finally broken in July 2015. Once again, the media coverage of this wonderful economic news was sparse to nonexistent.
All this good economic news at the end of August was widely applauded. The applause probably would have been louder and lasted longer if the wonderful news about corporate profits and real disposable personal income had received more emphasis. Most reports just covered the big increase in real GDP.
The news and all the new records increased the pressure on the FOMC to finally raise the target for the Federal Funds rate at their meetings on September 16-17. It also reassured investors and ordinary consumers that, despite all the economic turmoil in Canada, China, the Euro Zone and elsewhere, the US economy is doing pretty darn well!
Have a great Labor Day holiday. Rest assured that the US economy is continuing to chalk up decent growth and new economic records on a regular basis, even if the media largely ignore most of it.
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David R. Kotok, Chairman and Chief Investment Officer