Savings and Corporate Profits

When my back is broken
When the mountain moves away
All the dreams and promises
That we give, we give away
--INXS

John Hussman's weekly comments are always insightful, but this week's letter is among his best. While the entire letter is worth reading (twice), I wanted to focus on the section titled "The deficit of one sector must be the surplus of another."

The simple 'accounting identity' that Dr J notes is that corporate profits go up when people spend more--i.e., when savings go down. Since the credit market meltdown and subsequent 'stimulus,' government plus household savings has plunged to historic lows:

While the trend down in savings has been a secular one, the step change lower since 2008 primarily reflect deficit spending by government the likes of which the world has never seen. That spending winds up in corporate coffers. Indeed, the correlation between corporate profits as a % of GDP and government plus household savings as a % of GDP is striking:

It is also mean reverting. The ultra high level of corporate profitability currently in force cannot persist because the current deeply negative savings rate cannot persist. People will either save more voluntarily, or credit markets will force them to by cutting them off from more borrowing. As savings normalize, corporate profits will follow lower. John shows the correlation between growth in savings and growth in corporate profits here, with profits lagged two quarters:

John estimates that because current corporate profits as a % of GDP are about 70% above the long term average of about 6%, we can expect corporate profits to decline at roughly a 12% annual rate over the next four years:

I was somewhat surprised at the consistency of the relationship between profits and total saving. Would think that this relationship would break down at some point in a downward trending saving environment like the one that we've been in. A dearth of savings means little capital for productivity improvement which should grate on productivity (and profitability) at some point. Unless corporations fund all project out of retained earnings (which they are no where close to doing), then the system is gradually starved of capital.

One implication of Dr J's work is that big government types who disdain corporate welfare are supreme hypocrites, as it is government sponsored stimulus that lines corporate pockets in an unnatural manner.

Along with the cheap credit carry trade, government stimulus programs are State-sponsored transfers of wealth. In both cases, those who own corporate securities have been getting richer in an unnatural manner.