Are corporate profits stalling in Q3?

 

 - by New Deal democrat

One of the well-established long leading indicators is corporate profits. Typically they peak a year or more before the onset of a recession. And the reason makes sense: if there is profit pressure that lasts longer than a single quarter, i.e., it looks like it may be forming a trend, firms might cut their output, and more importantly, they are much more likely to engage in cost-cutting measures including laying off employees.

Here’s the long term view (note graph in log scale), divided into two periods for easier viewing:

Only in the oil related recessions of 1974 and 1991 did corporate profits not decline before their onset. Through Q2 of this year, profits were still rising. We won’t find out about Q3 officially until the end of November.

One way to try to get a more current handle on the profit situation is to track what firms are reporting to Wall Street. This is well-covered in the financial press. Weekly graphic updates are provided by, among others, FactSet.

Wall Street analysts’ profit estimates follow a predictable path. They are extremely optimistic in the quarters well ahead of the present. As the actual quarterly reports get closer and closer in time, those estimates are trimmed downward. The late financial analyist Jeff Miller studied this, and concluded that profit estimates were most accurate three quarters in advance. Further out they were too optimistic; closer in time they were too pessimistic.

The biggest time for downgrades in analysts’ estimates are right before the actual reporting begins. Then, when actual profits are reported, they beat those severely downgraded estimates, creating an atmosphere of investor optimism, and (during expansions!) it is off to the racetrack once again.

The typical pattern was followed in the weeks just prior to the Q3 2024 reporting season, which began a couple of weeks ago. In late September S&P 500 total earnings per share were estimated at 61.16:

By two weeks ago, right before reporting began, they had declined to 60.63:

By last Friday 1 in 7 companies in the S$P 500 had reported earnings for Q3. If this quarter followed form, actual reported earnings per share should be beating estimates sufficiently to cause actual plus estimated earnings to start to rise.

But that’s not what has happened this quarter so far. Instead, actual plus estimated earning per share have continued to decline, as of last Friday down to 60.07:

That’s *not* typical at all. 

Of course, as the vast majority of companies report earnings over the next few weeks that decline could reverse sharply. But if the poor actual results persist, that’s a big negative for corporate expansion, including hiring, in the quarters ahead. 

One week from Thursday the first estimate of Q3 GDP will be reported. While it won’t include corporate profits, it will include a reasonable proxy in the form of proprietors’ income, which sometimes turns contemporaneously with profits and sometimes with a quarter or so lag. Here’s what that looks like, compared with corporate profits since the pandemic:

In the meantime, we’ll get another weekly update from FactSet this Friday, and we’ll see if the downturn persists or reverses as more companies report.

A closer look at (why I’m not terribly concerned by) the recent elevated initial claims

 

 - by New Deal democrat

This week is another light one for economic data, so let me discuss a couple of points explaining why I am cautious, but not DOOOMing. Basically, because there are a lot of asterisks.

Today let me follow up on initial jobless claims. The typical best way to look at these is YoY. If the percentage goes up by more than 10%, that’s worth a yellow caution flag. If it stays up more than 12.5% for at least two full months, that’s a red recession warning flag, although even in that case there are a few false positives.

In the last two weeks, initial jobless claims (gold in the graph below) have been higher by over 15%. Ordinarily that would be a fairly serious cause for concern. But there were several special situations at work.

First of all, Hurricane Helene caused issues in the panhandle of Florida and even more dramatically in North Carolina. As I have done in the past, my workaround is to exclude those two States and see what the YoY changes have been in the other 48 States (blue). Even using that workaround, claims have still been up over 15%. But it turns out there were labor issues in motor vehicle plants in Ohio and Michigan that also impacted the numbers. Excluding those States as well, the YoY% changes in the remaining 46 States only exceeded 10% in the last week (red):

Part of what is going on is the base problem, i.e., what was happening during October last year. Note in the above graph that the nationwide total during the week of October 14, 2023 were among the lowest all last autumn.

To further show that, here is the same graph, but showing absolute numbers as opposed to the YoY% changes:

On the far right side, we can see that Michigan and Ohio had a much bigger effect during the first week of October, and abated last week. Additionally, on the left side of the graph, which begins in September 2023, we can see that late September and October had the lowest numbers (not seasonally adjusted) at any point in the last 13 months. So the YoY comparisons are especially challenging, but will largely recede in the next few weeks.  

As I wrote above, a couple of bad weeks is not overly concerning when viewed on a historical basis. Here is the same YoY information for the 1980s through 2007:

Note that there were many times when claims YoY were higher by over 10% or even over 15%, but receded after several months without there being a recession thereafter. That’s why in forecasting I look to see if the big increase in claims persists for at least two straight months.

Finally, here is an update of my “quick and dirty” forecasting system using the YoY% change in the stock market at well as (inverted) initial claims:

It’s hard to argue that we are in a pre-recessionary environment based on a couple of poor weeks for initial claims while the stock market is higher by almost 40% YoY!

Weekly Indicators for October 14 - 18 at Seeking Alpha

 

 - by New Deal democrat

My “Weekly Indicators” post is up at Seeking Alpha.

As per the analysis of monthly data that I wrote about this week, hurricane season continued to complicate the high frequency data as well. With that very big caveat, the underlying tone remained positive.

As usual, clicking over and reading will bring you up to the virtual moment as to the economic situation, and reward me a little bit for reporting and organizing it for you.

Despite Helene, housing permits and starts stabilized in September; but construction based yellow flag remains

 

 - by New Deal democrat

Much of the data that is being released, like yesterday’s jobless claims data, has to be viewed with an asterisk after it, because of hurricane disruptions. As an addendum to yesterday’s industrial production report, I failed to mention that the BEA that “the effects of two hurricanes subtracted an estimated 0.3 percent” from the total. Even with that increase, production would have been unchanged and manufacturing construction down -0.1%, and both would remains slightly down YoY, so the ultimate conclusion remains the same.

Similarly, Hurricane Beryl in July interfered with construction in July, and then permits and starts bounced back in August. Helene may have affected this month’s report, and Milton almost certainly will affect next month’s as well. Treat that as applying an asterisk to the analysis below.

The most leading metric, housing permits (gold), declined -42,000 to 1.428 million. Single family permits (red), which are just as leading and have very little noise, rose 3,000 to 970,000, the highest since April. Housing starts (blue), which tend to lag permits by a month or two, and are much more noisy, declined -7,000 to 1.354 million. All of the above were affected by very slight revisions to August:

All of this is a rebound from lows earlier this year, and it is what I have been expecting.   As I wrote two months ago, “we can expect permits to rise in the next several months, followed by starts,” for the simple reason that for 60+ years, mortgage rates have always led housing permits. And indeed that seems to have happened, given the downturn in mortgage rates (black in the graph below) this year (despite the increase in the past few weeks). :

That’s the good news. The bad news is that units under construction, the measure of real economic activity in this sector, declined another -28,000, and is now down -13.3% from its peak. This is very important, becuase while it is not so leading as permits and starts, it has always turned down, typically by more than -10% before a recession begins (the average is -15.1% and the median is -13.4%).  Here is the long-term graph comparing total permits (red, right scale) with housing units under construction (blue, left scale):

Here is the post-pandemic view:

Last month I hoisted a yellow flag “recession watch” for the construction sector, based on this metric being down more than -10%. It is now at the level consistent on average in the past with the onset of a recession.

While there had been a long time after single family construction turned down while multi-unit construction continued to increase and then plateaued, but this year both have declined. As shown below, multi-unit construction has continued to plummet, but the silver lining is that single family units under construction have remained stable for the past three months:

Further, as shown in the long historical view of housing units under construction and permits above, with one exception (the tech producer-centered recession of 2001), in the case of recessions, permits continued to decline sharply even after housing units under construction crossed the -10% threshold and well after recessions had begun. 

In our present situation, if I am correct that permits have bottomed and are starting to increase again, then housing units under construction will not decline too much further before bottoming as well. 

I concluded this review last month by saying “my base case is that this period of weakness is likely to turn around without a recession occurring. That’s why at this point there is only a housing sector ‘recession watch,’ meaning a heightened possibility, and not a ‘warning,’ meaning one is more likely than not. That continues to be my view - a period of softness without a recession - so long as mortgage rates continue to be lower than they were last year. With a hurricane asterisk.

Real retail sales increased in September, but concern - and their yellow flag - continue

 

 - by New Deal democrat

A periodic reminder, real retail sales is one of my favorite economic indicators, because it tells us so much about the state of the consumer, and since consumption leads employment, it is a short leading indicator for that as well.

In September retail sales in August rose 0.4% on a nominal basis. After adjusting for inflation, they rose 0.3%. The below graph norms both real retail sales (dark blue) and the similar measure of real personal consumption of goods (light blue) to 100 as of just before the pandemic:

Despite the improvement in the past three months, over the longer term since the end of the pandemic stimulus in spring 2022, real retail sales have been trending generally flat to slightly declining, while real personal consumption expenditures on goods have continued to increase.

On a YoY basis, real retail sales continue to be negative, at -0.7%, which remains problematic as it has all this year:

That’s because, over the past 75 years, a negative YoY comparison in real retail sales has usually meant recession. Obviously that wasn’t the case in 2022 and 2023, but at some point the historical relationship is likely to be valid again.

Finally, since real sales are a good if noisy short leading indicator for employment, here is the above YoY graph adding YoY payroll gains (red):

This forecasts that the YoY comparison in job reports is likely to continue to fade, despite the excellent September report. Future reports in the range of 75,000 to 175,000 appear more likely. Here is the post-pandemic close-up:

I began to be concerned about this series four months ago. Three months ago I said “The yellow caution flag is up,” and two months I concluded by saying that “the longer real retail sales go without posting a positive YoY number, the more concerned I will be.”Finally, last month I wrote that “This real retail sales report puts … really puts the pressure on initial jobless claims.”

Well, for the last two weeks even excluding hurricanes initial jobless claims have trended higher YoY - not enough to raise a yellow flag in that series, but nevertheless suggesting that the relative weakness in real retail sales, despite this good month, may be beginning to affect the jobs market. Because consumption still leads employment.

The shallow downturn in industrial production continues

 

 - by New Deal democrat

Before I get to the (relatively) good news in retail sales, let’s take a look at the bad news from industrial production.

On a monthly basis, production declined -0.3%. Manufacturing declined -0.4%. There were also downward revisions to last month. Both of these continue to slowly fade from their 2022 peak:

On a YoY basis, production is down -0.6%, and manufacturing production is down -0.4%:

For all intents and purposes, manufacturing has been in a shallow recession since late 2022, and that recession continues. This is something that has been well telegraphed by both the regional Fed new orders reports as well as the monthly ISM manufacturing report.

The only reason not to be more concerned is that, since the accession of China to regular trade status in 1999, production has stalled on a longer term basis, and there have been several equivalent or worse downturns without any recession having occurred, most notably in 2015-16:

Still, this is not good news, meaning that the burden is on construction and consumer spending on services to carry the economy forward to avoid recession.

Initial claims: *maybe* the onset of a concerning trend, but there are distortions galore

 

 - by New Deal democrat

As I indicated yesterday, today’s initial jobless claims report was particularly challenging, due to hurricane effects and unusual seasonal adjustments. The Columbus Day holiday may also have affected the numbers.

To cut to the chase, even after accounting for distortions, the number was very elevated YoY, which if it continues will be a real cause for concern.

First, let’s do the typical roundup. Nationally, initial claims declined -19.000 to 241,000. The four week average increased 4,750 to 236,250. With the typical one week lag, continuing claims rose 9,000 to 1.867 million:

On the YoY% basis more important for forecasting, without any special adjustments initial claims were higher by 19.3%, the four week average by 12.2%, and continuing cliams by 3.3:

If there were no special factors, the big YoY jump in initial claims would warrant a yellow caution flag.

The elevated claims numbers for the first two weeks of October preliminarily forecast a jump in the unemployment rate in the next monthly jobs report as well (here shown at the YoY% changes in each):

Now let’s look at the hurricane and other adjustments compared to last week (the graphs won’t be up at FRED until tomorrow, so I’ll just list the numbers).

On a nationwide basis, non-seasonally adjusted initial claims, at 224,763, were 42,369 higher than one year ago, or by 23.2%.

Last week Michigan and Ohio showed a big spike in initial claims. Per the DoL, this appears to have been motor vehicle production related layoffs. This week Michigan’s numbers declined -7,812 and Ohio’s -2,532. Still compared with one year ago, the two State’s numbers were higher by 2,237. In other words, most but not all of the spike has disappeared this week.

Surprisingly, Florida also showed a big decline this week, down -3,428. On a YoY basis, Florida’s claims were only 107 higher than last year. Either Milton won’t show up until next week, or the damage may have been so severe that people couldn’t file their initial claims yet. Either way, a huge jump is almost certainly going to happen within the next week or two.

North Carolina, by contrast, continued to have very elevated claims YoY, up 5,603 vs. last year.

Which means, combined, the two hurricane affected States contributed only 5,710 to the 42,369 nationwide increase. Thus the YoY% increase excluding those two States remains 21.2% - a very big jump (note that graph below does not include this week’s State numbers (red) for NC and FL):

But that brings us to the last issue, which is the effects of the national holiday. Remember that last week there was a 5% disparity in the YoY comparisons in favor of the non-seasonally adjusted measure. This week that reversed, with a 4% disparity in favor of the seasonally adjusted measure. Here’s what the YoY comparisons look like for both:

Last year’s 202,000 seasonally adjusted claims number was one of the lowest of the entire year, meaning that the YoY comparison this week was especially difficult. Against either the week before or after this week last year, YoY claims would only be higher by about 7%.

The bottom line is that the hurricanes are continuing to have a significant effect on jobless claims, but that even accounting for those, on a YoY basis claims remain quite elevated. But because of the holiday distortions, we will have to wait at least one more week to see if this is really the beginning of a concerning trend.