Behind U.S. GDP Data Is Reason for Recession Worry: Weak Profits

On the face of it, the latest government update on how the U.S. economy performed in the fourth quarter looked a bit more encouraging. Growth was revised to a 1.4 percent annualized pace from a previously estimated 1 percent, and the adjustment to gross domestic product was for a good reason -- consumer spending rose more than previously thought.

Yet beyond the headline number, there is a reason for some concern. Corporate profits plunged 11.5 percent in the fourth quarter from the year-ago period, the biggest drop since a 31 percent collapse at the end of 2008 during the height of the financial crisis. For 2015 as a whole, pretax earnings fell 3.1 percent, the most in seven years, according to the Commerce Department.

That’s “bad news,” said Nariman Behravesh, chief economist for IHS Inc. in Lexington, Massachusetts. History shows that when earnings fall, the economy often follows them downward into recession as profit-starved companies cut back on hiring and investment.

There are, however, some caveats to such a gloomy conclusion. Last quarter’s numbers were unusually depressed by a $20.8 billion penalty payment by BP Plc to settle claims over the 2010 oil spill in the Gulf of Mexico. Taking that into account, earnings fell about 7.6 percent, according to Bloomberg calculations. That’s still weak but not as bad as the 11.5 percent slump.

Behravesh also pointed out that the decline was heavily concentrated in the petroleum and coal industries, where profits plummeted by more 75 percent in 2015 as energy prices collapsed. That makes it less worrying from the point of view of the overall economy.

"Greater profits are a growth engine for the economy, but we are looking past this data today as it seems to be related to the big decline in oil," Chris Rupkey, chief financial economist with Bank of Tokyo Mitsubishi UFJ Ltd. in New York, said in an e-mail.

Jesse Edgerton, an economist with JPMorgan Chase & Co. in New York, was less sanguine. Yes, the poor earnings outturn was due to energy companies struggling with lower oil prices and manufacturers hit by a strong dollar, he said.

"But it also likely reflects the beginnings of a profit-margin squeeze driven by tighter labor markets, rising wages and weak productivity," he added in an e-mail to clients. And that, he suggested, is something to fear.

To contact the reporters on this story: Rich Miller in Washington at rmiller28@bloomberg.net, Alex Tanzi in Washington at atanzi@bloomberg.net. To contact the editors responsible for this story: Carlos Torres at ctorres2@bloomberg.net, Vince Golle, Brendan Murray

By: Rich Miller and Alex Tanzi

©2016 Bloomberg News