The Odd Favor A US Recession
$OIL, $USO, $BP, $JPM
The economic update that the US government released Friday was Ho Hum on its face.
Economists expected the revised numbers to confirm what they know already, that US GDP (gross domestic product) grew at an annual rate of just over 1% (1.4%) in Q-4 of Y 2015. The GDP Price Index was unchanged at 0.9%, as expected.
But, it is a mistake to dismiss the data release, even if away from your desk for the Easter Holiday.
The Big Q: Why is that?
The Big A: Well, because the government also published its 1st estimate of what happened to company profits in that frame. And the news is not pretty.
- Profits after tax with inventory valuation and capital consumption adjustments declined 8.4% on top of a 1.7% decliner in the Q-3 of Y 2015, so there is an earnings recession in the US even if the economy itself is not officially in a recession.
- For the FY 2015, profits declined 5.1% Vs a 0.6% decline in Y 2014.
That is the biggest decline since the 31% deep dive in the closing months of Y 2008 during the height of the financial crisis.
Profits last Quarter were unusually depressed by a $20.8-B penalty payment by BP Plc (NYSE:BP) to settle claims over the Y 2010 Oil spill in the Gulf of Mexico. But even after stripping out that 1-time charge, earnings fell 5.1%.
The Big Q2: Why is that important?
The Big A2: Well, history shows that when profits fall, the economy often follows them South. An earnings hit of the size reported has led to a recession within 3 years about 90% of the time.
Now the US central bank does not think the odds of a downturn are anywhere near that high. After all, a big reason why profits are dropping is because energy companies have been hurt diving Crude Oil prices, which should (on the surface) be good for the economy.
Hang on, that is not the only reason earnings are under pressure.
Companies are being pinched by poor productivity and rising labor costs on 1 hand and an inability to raise prices in a lackluster (low inflation) economy on the other hand.
The risk is that they will respond to the margin squeeze by cutting back on hiring and spending, and that leads to a recession.
The chief economist at JP Morgan Chase (NYSE:JPM) puts the probability of a US recession beginning within 2 years at 50%, and within 3 years at 67%. That is something worth paying attention to.
Have a terrific weekend.
HeffX-LTN
Paul Ebeling
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