The Big Idea

A healthy corporate report card

| June 7, 2024

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. This material does not constitute research.

Corporate profits surged as soon as the economy began to reopen after Covid lockdowns in 2020 and have remained robust.  The latest data show a modest decline in corporate profits in the first quarter this year, but the overall picture is still quite healthy. The national income accounts also reveal that profit margins are largely steady but still elevated compared to pre-pandemic readings. That’s a challenge for the Fed.

Corporate profits

As part of the National Income and Product Accounts (NIPA), the Bureau of Economic Analysis (BEA) calculates corporate profits.  Ultimately, the main source for these figures are data forwarded from the IRS compiled from corporate income tax returns. However, those data are only available with a lag, so the BEA has to extrapolate from the latest available tax data to create quarterly estimates for the most recent periods. Those quarterly estimates are derived from Census Bureau figures collected from various industries as well as the tabulations from a sample of corporate earnings reports.  The BEA’s corporate profits series consequently should be broadly in line over time with the quarterly shareholder reports that financial markets focus on, but the two do not necessarily have to be entirely consistent.

Recent trends

The BEA’s gauge of corporate profits jumped in 2021 and the first half of 2022 and has roughly leveled off since then (Exhibit 1).  The latest reading, for the first quarter of this year, was more than 37% higher than the 2019 level, close to double the increase seen in prices over that interval.

Exhibit 1: Corporate profits have moved higher

Source: BEA.

However, as I laid out in a piece last year, the BEA’s official corporate profits series is somewhat distorted because it includes the operating profits and losses of the Federal Reserve. The Fed went from earning record “profits” in 2021 and early 2022 to massive “losses” since late 2022, as it is paying out more in interest on reserves and RRP than it earns from its securities portfolio.

Since the Fed’s operating income is mostly an accounting issue—any “profits” are simply remitted to Treasury while “losses” are handled by writing an IOU to Treasury and printing money to cover its payouts—a proper reckoning for Corporate America requires stripping the Fed’s numbers out of the aggregate profit figures.

After excluding the Fed from corporate profits, the runup in 2021 and 2022 is less steep, but “ex-Fed” profits have continued to climb (Exhibit 2).  By the first quarter of this year, this aggregate was 46% higher than the 2019 average, almost triple the cumulative increase in prices over that period. For all of the talk of higher interest rates potentially impeding business activity, Corporate America has continued to thrive.

Exhibit 2: Corporate profits, excluding the Federal Reserve, keep climbing

Source: BEA.

Profit margin

The BEA also publishes data on how real gross value added for nonfinancial domestic corporations is allocated between costs, taxes, and profits.  This allows a look into profit margins, or after-tax profits as a percentage of the price charged per unit of gross value added for this subset of businesses (Exhibit 3).  Limiting the data to nonfinancial firms conveniently avoids the measurement issues related to the Federal Reserve.

Exhibit 3: Nonfinancial domestic corporations profit margin is up

Source: BEA, Santander US Capital Markets

The numbers clearly show that profit margins widened after the pandemic, inching up from a 10% to 12% range to 12% to 14%.  The first quarter reading did fall from 13.8% to 12.9%, which could signal the beginning of a pullback, but until the gauge falls back below 12%, it would be premature to conclude that Corporate America is losing steam.

Monetary policy implications

These profit margin data suggest that the economy remains solid, at least for now.  More importantly, they tell us something about pricing power.  When viewed from a distance, the expansion of profit margins after the pandemic, at a time when both labor and nonlabor costs were surging, is extraordinary.  This speaks to a significant shift in pricing power that has fed the inflationary impulse that has plagued the Fed since 2021.

There have been anecdotal reports this year that consumers are starting to get their mojo back and are beginning to become more resistant to price hikes.  However, the inflation genie was let out of the bottle in recent years, and whatever increase in resistance to higher prices consumers are exhibiting is nowhere near the norm in the 2010s, when businesses were constantly complaining that they had essentially no pricing power at all.  I suspect that getting inflation back to 2% on a sustainable basis will require squeezing profit margins back down to something closer to the pre-pandemic trend.

Stephen Stanley
stephen.stanley@santander.us
1 (203) 428-2556

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

Important disclaimers for clients in the EU and UK

This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).

The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.

This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.

This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.

This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.

The Library

Search Articles