Corporate Profits and Interest-Rate Prophets

Wednesday's profit number is one Greenspan will be watching.
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Copacetic

JACKSON HOLE, Wyo. -- Third-quarter

profit-margin

numbers will be released Wednesday. Recent figures appear in the table below.

Top-line margins in our table equal

corporate profits with inventory valuation and capital consumption adjustments

divided by the

gross product of nonfinancial corporate business

-- we use these measures of profits and output because

Greenspan

expresses a

preference for data from this sector. (Top-line margins also equal

unit profits from current production

divided by

price per unit

of gross product. You can track these ratios yourself; Table 12 in the

gross domestic product

release contains the numbers you need to calculate them.) After-tax margins equal

profits after tax

divided by same.

Three notes.

(a) What's the real trend here?

Are margins shrinking? Are they leveling out? Or are they headed decidedly higher?

Perhaps the third-quarter numbers to be released Wednesday will shed light.

(b) The central bank is watching.

G. Love referenced margins (numbers through the first quarter were available at the time) when he

testified in June.

For the period immediately ahead, inflationary pressures still seem well contained. To be sure, oil prices have nearly doubled and some other commodity prices have firmed, but large productivity gains have held unit cost increases to negligible levels. Pricing power is still generally reported to be virtually nonexistent. Moreover, the re-emergence of rising profit margins, after severe problems last fall, indicates cost pressures on prices remain small.

The focus on margins was already keen then. Given that commodity prices (including oil) have

continued to firm; given that productivity

gains

have shown

signs of leveling out; and given that the pricing-power thing might be changing -- compare "noticeably fewer comments by business contacts about their inability to raise prices" from the

minutes of the Oct. 5

FOMC

meeting to "anecdotal reports from around the nation continued to underscore the difficulty or inability of most business firms to raise prices in highly competitive markets"

earlier in the year -- that focus has arguably grown keener still.

(c) That cute older stocks guy?

The way popular

one out of Omaha?

He looks closely at the ratio of (regular) after-tax corporate profits (which you can find in Table 10 of the GDP release) to (regular) GDP (which you can find in Table 3). It pierced 6% back in (surprise) 1995 and was still holding above that mark as of the second quarter of this year.

In the context of

Things That Would Have to Happen in order for stocks to return even an average 12.9% per year over the next decade -- that number's from a recent survey of folks who have been investing for more than 20 years -- the Nebraska Man had this to say.

Corporate profitability in relation to GDP must rise. You know, someone once told me that New York has more lawyers than people. I think that's the same fellow who thinks profits will become larger than GDP. When you begin to expect the growth of a component factor to forever outpace that of the aggregate, you get into certain mathematical problems. In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%.

Anyway.

For what it's worth.

Side Dish

Anyone who thinks the best Italian restaurant in

America is anywhere near the Bay Area needs help.

Lots and lots of help.

Profitability?

On track to shoot way higher.

Likely to rise gradually.

Leveling out.

Likely to sag gradually.

On track to plunge.