Profits Are Well Thawed Out

Posted by Vident Financial on 1/14/22 9:30 AM

In our previous analysis, we described the odd pandemic economy dynamics of profits getting deferred ("Weird Recovery Part 2: Where Are the Profits?," Vident Financial blog, 2-22-21) and then unfrozen ("Profits Got Unfrozen," Vident Financial blog, 8-17-21). To recap: The collapse in profits during the worst of the pandemic made things look worse than they really were, and the large spike in profits in early 2021 made things look better than they really were. What really happened is that the shutdowns mostly deferred business activity instead of destroying it. Mostly. Some haircuts, dinners out, vacations, and mani-pedis were lost forever, but the big ticket items (durable goods, homes, cars, information technology) simply got made and purchased later.

Since business didn't slow down as much as consumption, the inventory to sales ratio spiked:

(Source: FRED, January 2016 – September 2021)

That spike was the "frozen" profits, value created by business, but not yet "booked" as profit by the accountant because it had not yet been sold. Then, as consumers started to buy, inventory got liquidated, and profit got unfrozen:

Corporate Profits Change

(Source: FRED, Q1 2010 – Q3 2021)

As you can see, the bounce-back from early 2020 was larger than the profit shrinkage, which means that the part of the profit spike which was playing catch-up from the shutdowns is probably over with, or nearly so. From now on, business will have to earn its growth, not just ride a cyclical recovery. If the outlook for growth is low, then profits will tend to lag.

The opinions expressed herein are those of Vident Financial at the time of publication and are subject to change. This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only and on the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the information described herein, any risks associated therewith and any related legal, tax, accounting or other material considerations. Recipients should not rely on this material in making any future investment decision.

Investors cannot invest directly in an index. Indexes are not managed and do not reflect management fees and transaction costs that are associated with some investments. Past performance does not guarantee future results.