The Big Idea
Surging corporate profits
Stephen Stanley | October 1, 2021
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Businesses have enjoyed a sharp bounce back in revenues and profits since the economy reopened last year. Corporate profits had returned to pre-pandemic levels by last summer, and after a Covid wave and a pause in in the economy at the end of last year, corporate profits have zoomed to unprecedented heights in the first half of 2021. Business investment, employees, suppliers and others should see the benefits.
The Bureau of Economic Analysis estimates quarterly corporate profits as part of GDP calculations. The headline figure reports profits after adjusting for inventory valuation and capital consumption. The BEA also reports after-tax profits, breaks out profits of domestic companies and further divides those into financial and nonfinancial businesses.
Overall corporate profits plunged in the first two quarters of 2020 as output collapsed (Exhibit 1). Amazingly, the level of corporate profits in the third quarter bounced to slightly above the last quarter of 2019. In contrast, real GDP did not return to its pre-pandemic level until the second quarter of this year.
Exhibit 1: Corporate profits have surged
After a flattish finish in the last quarter of 2020, corporate profits exploded higher in the first half of this year, rising in the first two quarters by an 5.1% and 10.5% respectively—and these are not annualized percent changes. By the end of June, the level of corporate profits, at $2.82 trillion, was over 17% above the pre-pandemic reading. Nominal GDP at the end of June, by comparison, was only about 5% higher than the pre-pandemic figure.
Parsing corporate profits
After-tax corporate profits also have ascended to previously unseen heights (Exhibit 2). The contours are similar to the before-tax figures, a quick bounce back in the summer of 2020 followed by a sharp leg higher in the first half of 2021. As of the end of June, after-tax profits were 16.8% above where they finished 2019.
Exhibit 2: After-tax corporate profits have surged, too
All of the surge in corporate profits has occurred among domestic firms. In fact, the Rest of the World category, which measures net payments to and from overseas firms and subsidiaries, has fallen slightly in the first half of 2021 and remains lower than late 2019. In contrast, domestic corporate profits have soared (Exhibit 3). In fact, at $2.36 trillion in the second quarter, domestic corporate profits were nearly 25% higher than before the pandemic.
Exhibit 3: Domestic corporate profits have led the surge
Financial firms have benefited from easy financial conditions and strong economic growth. However, the gains seen this year, while significant, do not seem out of line with the upward trend that had been in place for several years prior to the onset of the pandemic (Exhibit 4).
Exhibit 4: Domestic financial corporate profits have been in line with trend
In contrast, corporate profits for domestic nonfinancial firms have skyrocketed at a pace not seen in decades (Exhibit 5). In the first two quarters of this year, profits of domestic nonfinancial corporations increased by about $350 billion, similar to the aggregate increase seen for the nine years up to the pandemic. The total at the end of June was over 30% higher than the last 2019 reading.
Exhibit 5: Domestic Nonfinancial Corporate Profits
Economic implications of the profit surge
Businesses are both buyers and sellers of goods and services in the economy. They both pay and receive prices. Thus, the health of the corporate sector, while in large part a result of consumer and business demand, also helps to determine that demand.
A highly profitable corporate sector, all else equal, is more likely to recycle some of those funds back into their businesses via investment. Spending for equipment and for intellectual property (mainly software and R&D) has been robust since last summer. I would expect those components of GDP to continue to advance at a solid pace.
Another possible implication of a highly profitable corporate sector is that it will be more able and willing to pay up for scarce labor (as well as physical inputs). It is remarkable that corporate profits have risen so fast even as input costs, including for labor, have been increasing far more rapidly than usual. These data confirm that profit margins have widened. At the end of the day, whether consumer price inflation settles back to 2% or remains above the Fed’s target will depend mostly on whether consumers are willing to stomach higher prices, but those attitudes, in turn, will depend on a variety of factors, including the employment and wage environment.
In the context of political debates over who pays corporate taxes, economists who have rigorously studied the question widely agree that corporate taxes are ultimately paid in large part by workers, consumers, and investors. Likewise, the dramatic jump in corporate profits is likely to be disseminated widely back into the economy over time, benefiting workers as well as other businesses that sell products and services to those corporations.
Finally, a flush domestic corporate sector could accelerate whatever structural transformations in the global economy may follow from evolving attitudes regarding trade relations, especially with China, and changes in business preferences toward far-flung global supply chains. It seems likely that, where possible, manufacturers and retailers may look to rein in their supplier networks, especially given the intractable bottlenecks at the nation’s ports. That process can be involved and expensive, but if corporations have an extensive cache of resources to pull from, they can, in theory, be more aggressive and faster to adopt changes.