Analysts and investors pleased with resilient corporate profits aren’t factoring in the macro read-through of so-called “Greedflation.”
That’s according to SocGen’s Albert Edwards, who on Wednesday revisited one of 2023’s most heavily-debated economic dynamics.
Top-down strategists naturally think and write in terms of S&P 500 companies. After all, their job is to forecast the index, which entails projecting aggregate index profits. Currently, S&P 500 companies, considered together, are experiencing a very mild earnings recession. Bulls generally believe earnings will trough in Q2 or Q3, before inflecting sharply. Bears may agree with a Q3 trough (or maybe Q4), but they think a much deeper contraction is in store, and generally think the inflection won’t likely occur this year, but rather next.
Edwards didn’t spend a lot of time on that debate in his latest. Instead, he revisited the BEA’s whole economy national income accounts profits data, which he prefers to reported earnings from corporate America. The BEA, he reminded readers, “cast their net far wider [and] tries hard to scrub their estimates of profits of (legal) accounting manipulations that are embedded within the quoted company reported profits series.” In addition, the government figures include unquoted smaller companies, who Albert gently noted “have less pressure to massage profits to ‘beat’ estimates.”
One key point is that for Edwards, profits lead the cycle. So, as profits fall, the C-suite dials back capex and hiring in an effort to protect the bottom line, which in turn leads to recessions. And why do profits fall in the first place? Well, a lot of reasons, but from a 30,000-foot perspective, rising costs and waning demand are key factors. If falling profits cause recession, and margins remain elevated due to Greedflation, then recession will be delayed, and so will inflation’s return to target. That means higher for longer rates.
What makes the pandemic-era economy so unique is the extent to which margins haven’t rolled over commensurate with the increase in costs. Edwards has repeatedly warned that this anomaly risks destroying capitalism as we know it. He reiterated as much on Wednesday. “This is without precedent in US economic history and led me to say that the capitalist system is broken,” he wrote.
The latest BEA data on whole economy profits “tell a story of US profits falling, but not very quickly,” Edwards said, on the way to looking at domestic non-financial profits with two adjustments, one for inventory and one which puts depreciation on an economic rather than tax basis — the series proxy for underlying profits.
The takeaway, Edwards said, is that underlying profits “may have fallen slightly QoQ but they are still 4% higher YoY.” He described that with one word: “Wow!”
He also charted the two series as a share of GDP, and looked at the data going back 70 years. Taxes, he noted, are becoming “increasingly irrelevant” (the pre- and post-tax series are converging). If you assume the pre-tax figures are a better proxy for underlying profitability, margins aren’t totally without precedent. “We are back to the 1950s!” Edwards quipped.
The crux of the issue (and certainly the most straightforward way to visualize Albert’s overarching point) is that profitability has barely responded to the rise in unit costs.
“This is where it is clear the recent post-pandemic rise in unit profits… is without precedent and this more than anything else, defines profit-led inflation, or Greedflation,” he wrote.
I should note that Albert’s latest weekly is thorough. Sometimes, his weeklies are lighthearted frolics through various topics utilizing diverse sources, but make no mistake: Edwards can get serious when he wants to, and he’s still analytically formidable. Above, I barely scratched the surface. He took a deep dive into the BEA release.
Albert explained why this is important. The analysis matters “for economists and the stock market because Greedflation, in keeping profits higher for longer, has delayed the recession,” he wrote.
The figure above is key. Domestic non-financial profits “are so buoyant they are actually slightly lagging the business investment cycle rather than leading it, as is usually the case!” Albert exclaimed.
The implication is that this won’t go on forever, or if it does, it’s an existential problem for capitalism. Albert walked through several additional visuals (he used a dozen total), delivered an extensive explanation of each and how they fit into the debate, before summing it all up in four well-written paragraphs which were mostly devoid of hyperbole in favor of a more serious cadence.
I’ll leave you with two of those four paragraphs which I think are well worth quoting in full. To wit, from Edwards:
Either analysts are ahead of the game and a whole new profits recovery has just begun and the threat of recession is in the past. Or alternatively the unprecedented resilience of profits (due to Greedflation) has caught analysts out and they have been forced to revise up forward earnings because they had downgraded EPS estimates too aggressively having expected a ‘normal’ profits downturn. (The recent enthusiasm about A.I. has undoubtedly contributed to recent upgrades.)
On the latter view, we may still be in a profits downcycle that will cause a (delayed) recession. Analysts reveling in companies’ higher margins at the micro level have not realized the macroeconomic implications of Greedflation, namely that because profits have remained higher for longer and driven inflation higher for longer, consequently, interest rates stay higher for longer and hence the coming recession will be deeper for longer. And incidentally, the extent that labor hoarding has entirely predictably occurred during this slowdown (because of the labor shortages in recent years) means profits could actually fall off a proverbial cliff in the coming quarters due to higher than usual operational gearing of the corporate sector.
Thank you, Walt, for addressing these very important topics. I also like your timing. Warren Buffet and Charlie Munger have been talking for years about the need to raise taxes on the wealthy. But their advice goes unheeded by our political institutions.
Greedflation is real and senseless. American affection for the richest of the rich, our idolatry of the wealthiest of the wealthy, doesn’t balance the federal budget, and, aside from a few exceptions like Buffet and Munger, who donate large amounts of their extensive wealth, the wealthiest among us do not support the least among us. And it’s not their job. The United States government is supposed to receive and use tax revenue to increase the lot of the rest of the country through investment. With Biden, that’s happening to a degree. But our country is also saddled with a growing and perilously large amount of debt. Something is going to have to give.
In the 2008-2009 recession we abided with the top 1% with a certain amount of strain. We were able to manage inflation, thanks to Ben Bernanke. But today the wealth is even more concentrated. The Trump tax cuts exacerbated and strained any sense of balance of our economy. Reagan’s trickle-down economics was bad enough. But with the Trump tax cuts, the balance of the money in our economy skews more dramatically. The money doesn’t trickle down and never did.
Even before the 2008-2009 recession we had Greedflation. It was not as pronounced at the time. And we did not call it that. But we recognized the top 1% as a distinctive level of the socio-economic stratosphere. Now with the Trump tax cuts in force, things are even more out of kilter, and today we’re seeing the consequences in the socio-economic effects of the distribution of wealth.
Folks, I’m spit-balling here, trying to make a reasonable assessment of what I see. I’m no economist. But I feel Warren Buffet and Charlie Munger are right to implore the government to raise taxes. What we’re seeing now in terms of wealth concentration is not merely to the top 1%, though there’s still a lot wealth concentrated there. I’m talking about the flow of money from the top 0.2%. Sounds to me like the money at the top of the economy is yielding our collective experience of this thing we call “Greedflation,” which is another way of saying, we need to raise taxes on the wealthiest of the wealthy because it complicates our ability to manage the country’s economic affairs.
Not to mention, failing to properly tax the wealthy, and providing them with loophole upon loophole to avoid paying taxes is just plain wrong.
Dave, I appreciate your comment but, respectfully, I think that government is purposely avoiding the needed tax raise for the wealthy because a voting majority of the Congress is living off their largess. I suspect that at least half the Congress has breached millionaire status while in Congress and some hit that boarder before gaining their office, still as a result of some sugar daddy (this is my spitball). It’s an old chestnut but these folks have learned not to bite the hand that feeds them. On a proportional basis this year’s Federal tax bill was 11%+ of my total cash income, up from 9% before the Trump cuts. However, the reason it was this low is simple, I gave away a quarter of everything I earned and I invest a lot in municipal bonds. The only way this is going to get better is a idea with whiskers, eliminate all private political contributions .. period. No more PACs, fat cats, anyone private. Designate a modest government sum for every legitimate candidate. Also, use the Israeli model, no campaigning of any kind until 60 days before the election. Trump would be a schoolyard bully if he wasn’t on the news and couldn’t raise campaign funds. One time I asked a politically connected friend what it would cost me to buy access to a state legislator in our state. Without hesitation he told me that $5000 would guarantee a supported individual would take my calls and $10k would get me a favor. I got regular access to my local mayor for $100 (and my name in the paper as a “supporter.” I got a couple of favors as well.
A general failure to enforce and advance antitrust laws is also a major contributor. Many industries have seen considerable consolidation, and with the rise of technology, companies have gotten better at the soft art of manipulating markets, suppliers, etc.
Maybe I’m missing something, but I would appreciate your view on the following. In a free market, companies always try to charge the maximum price the market will bear (or the price that maximizes profits). So presumably they have been forever trying to do this, but recently they were very successful in doing so, more than in prior periods. My question is what explains their outstanding recent success in raising prices, despite the reasonable assumption that they have probably been attempting this all throughout the history of capitalism?
Actually, your premise is not quite accurate. Companies don’t charge the maximum they think they can get because of a much ignored economic law, that of the elasticity of demand. Many factors affect the level of demand, including prices charged. Items that are necessities such as food and fuel will absorb price increases fairly well but demand will be negatively affected. Although a price increase may raise revenue, it may well reduce the customer base. If the item is a discretionary product or service a price rise may well cause overall revenue to fall, while a price decrease may result in a rise in sales. However, rising sales revenue that comes from a decrease in price seems good on the surface but it also means more units have to be sold, at a lower gross profit and a possibly higher fixed cost. There is nothing simple about pricing and profit. So ultimately what companies seek to do is balance prices, costs and the structure of both in order to produce the best effect on profits at whatever price. One other thing, prices aren’t the only way to increase revenue and produce favorable elasticity. When Lee Iaccoca took over Chrysler and it was nearing bankruptcy he raised sales by changing it’s car warranties from a standard two years to five years. Sales shot up. The beauty of the plan was that for the first two years the change cost the company nothing. That gave the company two years to improve its quality, reducing future warranty costs and raising profits. More recently KIA extended its warranty to ten years, more on some models. Again, this helped increase sales and establish a strong foothold in the market. Any major feature of a product can create favorable elasticity, favorable warranties, cupholders, glass refrigerator doors, 120v power outlets in Ford trucks, etc.
The economist Isabella Weber (good recent Odd Lots podcast episode) has a lot of thought and analysis on this: coordinated markets can raise prices (and profit). Teddy Roosevelt’s anti-monopoly Trust Busting was how the US somewhat avoided becoming an Oligarchy.
The pandemic created the supply chain shocks and Business could all raise prices at the same time without losing customers to competition (who according to theoretical capitalism cuts prices to win). The tight labor market due to a demographic shift and change on Immigration allows workers to retain jobs and keep spending.
That’s the point of Edwards article (and Weber indicates the same) – this dynamic is unsustainable (because it literally creates inflation) and at some “unexpected” point consumers will disappear and businesses habituated to “price over volume” will have shocking misses (likely with high interest can’t borrow anymore bankruptcies too).
Thanks, Anonemouse.
I’m concerned about people at the bottom being hurt. I’m not interested in the survival of the fittest, which is an unreality. My wife and I live comfortably. We’re also healthy. I’m not concerned about us. We do well with our modest investments. It’s not hard make a couple of million dollars in the market. You need capital, some market savvy, and patience. And useful perspective from a guy like Heisenberg doesn’t hurt either.
But Greedflation is a product of a system tilted in favor of those at the tippy-top of the US wealth pyramid. It doesn’t benefit me. It benefits only the extremely wealthy. And I expect wealth distribution to those at the top of the pyramid, because it is historically reinvested in the economy. But the markets and the economic system ought not to indirectly preclude those at the bottom because a higher level of inflation, triggered by Greedflation, makes their small income more meager each day inflation rises.
I hope the Fed can push rates to 2% again. But the US tax system must be amended to temper Greedflation. The Trump tax cut favored the extremely wealthy. Like Trump’s modus operandi, it’s the worst kind of self-dealing because it actually hurts some of our people.
We voted Trump out of office. We’re still processing the reasons why he had to leave the Office of the Presidency.
I don’t believe we should abide with the Trump tax system. It’s uneven and unjust.
Interesting take on things. Thank you.