What Will the “Corona Virus Correction” Reveal?

It’s only when the tide goes out that you learn who’s been swimming naked.

Here are my top 9 questions: #

1. Is it true that Corporate Profits have been “Anemic” since 2014 and this has been obscured by “Financial Engineering”? 3 4
   • • Eric Basmajian writes on Seeking Alpha (Feb 28, 2020):
       (click blue CiteIt.net arrows above and below quote to expand)

       Corporate America has been plagued by anemic economic growth in this economic cycle. Masked by the rising share price of roughly 500 companies, thousands of corporations that aren’t publicly traded have been forced to operate in a low-profit growth regime.

       Financial engineering has allowed publicly-traded companies to report strong earnings growth. Total corporate profits reported in the GDP report is a far more accurate, albeit delayed, data source on the real (non-adjusted) profits generated by the corporate sector.

       From 2014 through the start of 2018, corporate profits declined. The one-time spike in profits after 2018 was due to the corporate tax cut. Essentially, without the corporate tax cut, the corporate sector has seen virtually no profit growth since 2014.

       This assessment might seem “off” if you’re used to charts like this:
       Chart 1: from JPMorgan (page 7):
       

   But note that the S&P Earnings per share are heavily influenced by the share count reduction caused by buybacks.
   

   • Here’s a different chart that features “total profits before taxes:“Chart 2: Corporate Profits Before Taxes: St Louis Federal Reserve
     
   • Notice how flat profits have been since 2014 (actually it looks to me like they have been roughly flat since 2012).5
   • Am I wrong to be concerned that companies  appear to have engineered attractive EPS (Chart 2 – Earnings per Share from JPMorgan) by borrowing from the bond market (with funding from pension system) and weakening their credit ratings (many are rated just above “junk bond status”)?

   • Investors beware: Corporate profits are lower today than in 2014 : Marketwatch (Sept 26 2019)

   • Huge Disparity in Corporate Profits Hints at Something Amiss : Wall Street Journal (Dec 19, 2019)

2. Is it true that Corporations have been the dominant buyer of their own stocks in 2018 and 2019?

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Note to Bethany Mclean’s Readers: There is a newer version of this piece.

Summary:

The corona virus may turn out to be the “straw” that broke the camel’s back.  Whether or not this “straw” turns out to be large, it is important to focus on the rotten fundamentals it exposed.

When we look back on this era’s economy, we will remember a time of “Anemic Growth” when stock prices were propped up by Financial Engineering — a BuyBack Bubble that was funded by Corporate Tax Cuts and Debt that masked their true performance.

Eric Basmajian writes on Seeking Alpha:

From 2014 through the start of 2018, corporate profits declined. The one-time spike in profits after 2018 was due to the corporate tax cut. Essentially, without the corporate tax cut, the corporate sector has seen virtually no profit growth since 2014.

Financial engineering has allowed publicly-traded companies to report strong earnings growth.

Corporations were able to pump up their stock price by borrowing money in the bond market and using it to purchase their own stock.  It used to be that there were dozens of AAA-rated companies; today there are only two.  Corporate debt now stands at $10 Trillion, half of which is rated BBB, just above “junk” status.  This corporate debt will make the recovery much more difficult.

Inspiration:

I was inspired to write this post by a 9 minutes story on NPR’s Planet Money about Corporate Debt:

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