Bernanke, Greenspan Disagree on Impact of Corporate-Profit Peak
AG: a peak in profit margins is a sign the economic expansion may be past its prime and the risks of recession are growing.
Bernanke: the topping out of margins may instead herald better times for U.S. workers as wage increases start to catch up with the five-year boom in corporate profits.
Bernanke, Greenspan Disagree on Impact of Corporate-Profit Peak
By Rich Miller
March 12 (Bloomberg) -- The disagreement between Alan Greenspan and Ben S. Bernanke about where the U.S. economy is headed boils down to just one word: profits.
For the 81-year-old former Federal Reserve chairman, a peak in profit margins is a sign the economic expansion may be past its prime and the risks of recession are growing. For his 53- year-old successor, the topping out of margins may instead herald better times for U.S. workers as wage increases start to catch up with the five-year boom in corporate profits.
Many economists -- including some who worked with Greenspan at the Fed -- side with Bernanke. If companies are accepting lower profit margins instead of raising prices to help offset increasing wages, that helps contain inflation. It also helps forestall the kind of Fed-engineered interest-rate rises that have often triggered recessions in the past.
``Greenspan is a smart fellow,'' says Edward Gramlich, who served with the former chairman as a Fed governor from 1997 to 2005. ``But profits are high and this is normal readjustment. I wouldn't have thought it means a recession.''
Profit margins for non-financial corporations rose to 13.7 percent in the third quarter from 12.8 percent in the second, according to the Commerce Department. That's the highest level since the second quarter of 1969 and more than double the 6.2 percent in the fourth quarter of 2001, just as the current expansion began.
Holding Down Wages
Meanwhile, corporate profits increased to a record 12.4 percent of the economy in the third quarter from 7.1 percent five years earlier, as companies held down wage increases while their revenues rose.
That may be about to change. Unit labor costs rose at a year-over-year rate of 3.4 percent in the fourth quarter, versus 1.5 percent a year earlier. Almost half of the Standard & Poor's 500 companies reporting fourth-quarter results showed narrower margins, according to data compiled by Bloomberg.
Wall Street analysts surveyed by Bloomberg see per-share earnings growth among S&P 500 companies slowing to 6.7 percent this year from 16.6 percent in 2006.
That's what's bothering Greenspan, who puts the chances of a recession this year at one in three.
``We are in the sixth year of a recovery; imbalances can emerge,'' he said in a March 5 interview. ``It is possible that we can have a recession at the end of this year.''
Capital Spending and Hiring
Behind his forecast: concern that contracting profit margins will force companies to cut capital spending and hiring.
Signs of this pressure are already evident. Shipments of non-military capital goods excluding aircraft dropped 2.7 percent in January, the biggest month-to-month decline since September 2001. Orders slumped by the most in three years.
``When earnings growth slows and margins narrow, American business is very quick to cut back on expenses,'' says Allen Sinai, president of New York-based Decision Economics. He sees the odds of a recession this year at about 20 percent.
Still, most economists, including those at the Fed, say it's premature to declare the expansion near an end. Indeed, some have grown more optimistic as the economy continues to expand and employment keeps growing in the face of the housing slump.
``In mid-2006, I was in the pro-recession camp due to high oil prices and the impending housing collapse,'' says Robert Gordon, a professor at Northwestern University in Evanston, Illinois, and a member of the National Bureau of Economic Research committee that determines the start and end dates for economic declines. ``Now I think we'll avert a recession.''
A More Positive Light
Rather than seeing peaking profit margins as a precursor of tough times, Bernanke portrays them in a more positive light. He calls it ``normal'' for rises in inflation-adjusted wages to catch up with profits, especially when productivity has been strong.
``I would think we will see further increases in real wages going forward.'' he told lawmakers on Feb. 15.
Noting that profit margins are ``high by historical standards,'' he said companies might absorb the extra labor costs rather than recoup them by raising prices.
``Inflation is very benign,'' Rajiv Gupta, chief executive officer of Philadelphia-based Rohm & Haas Co., the world's biggest producer of acrylic-paint ingredients, said on Feb. 16. ``We don't see big price increases.''
History seems to side with Bernanke. In the last expansion, margins began falling in the fourth quarter of 1997; there was no recession until March 2001.
`Closer to the Middle'
``I think we are closer to the middle of an expansion than the end,'' says Laurence Meyer, who served with Greenspan at the Fed from 1996 to 2002 and is now vice chairman of St. Louis-based Macroeconomic Advisers LLC. His firm sees the economy growing 2.7 percent in 2007 after expanding 3.1 percent in 2006 as profit growth slows to 6.6 percent from 12.8 percent.
Alan Blinder, a Princeton University professor who was Greenspan's vice chairman from 1994 to 1996, says the probability of a recession this year is ``pretty low, not more than 20 percent.''
Analysts have generally underestimated profit growth during the current expansion. In January 2006, the consensus forecast for annual per-share earnings growth among S&P 500 companies was 14.6 percent. Actual results were 2 percentage points higher.
Energy
Much of the forecast decline in S&P profit growth this year is in the energy sector, where analysts see earnings falling 4.6 percent after rising by 21.1 percent in 2006.
Steven Wieting, managing director of Citigroup Global Markets in New York, said this doesn't worry him. Since the U.S. is a net oil importer, lower energy prices are good for the economy.
The booming profits of the last five years also haven't spawned the sort of financial excesses that have often led to recessions in the past. That makes the economy less vulnerable should margins contract.
Companies stepped up capital spending as profits rose during the last five years. Yet they have financed their increased outlays mainly through internally generated funds, rather than by borrowing.
Non-financial companies spent $47.1 billion more on capital investment last year than they generated internally, according to Fed statistics. That's well below the record $310.8 billion financing gap in 2000.
The stock market has also been more restrained than it was during the go-go years of the late 1990s. The S&P 500 rose 14 percent last year and 3 percent in 2005. That compares with jumps of 20 percent in 1999 and 27 percent the year before. The index now trades at about 15 times forecast earnings, less than the monthly average of 27.3 times during the past 10 years.
``There's been a healthy skepticism on the part of investors and corporate executives about the surge in profit margins,'' says Jack Ablin, who oversees $50 billion at Harris Private Bank in Chicago. ``That's going to give us a cushion as margins contract.'' |
