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Economic Dissonance In Corporate Profits

June 21, 2010
A passing sentence in Barron’s this week caught my eye and really highlighted the disparity I’m seeing between the macro corporate outlook and economic reality on the ground. Market analysts are predicting $96.43 of S&P 500 earnings in 2011, which would top 2006 as the record year for corporate profits. Yet a quick survey of the the broader US economic landscape suggests rough times ahead. How to reconcile these two images?

Warren Buffett has pegged 4% – 6% as the typical range for corporate profits as a percentage of GDP. Of course, Buffett is no economist which only bolsters his credibility. In 2006, corporations hauled in 10% of GDP, much of it at the expense of labor, aka consumers when they’re not laboring. In fact, the decade-long pressure on wage income played a significant role in the credit crisis as consumers borrowed against homes, stocks and credit lines in the face of declining real wages to maintain standard of living.

Of course, this whole house of credit imploded in 2008/2009 as the global financial crisis reeled from too much unsupported debt but not even two years removed, corporations have fully recovered, as evidenced by projected record profits in 2011. Meanwhile, unemployment hovers around 10% – 16% depending on the measure used. Many states have crushing budget problems, with the biggest problem in California, already the world’s eighth largest economy independent of the other 49 states. And if the Gulf state economies weren’t having issues before, the BP gulf spill will ensure rough times for months or more likely, years to come.

The usual arguments about unemployment being a lagging indicator and rebounding corporate profits leading to increased spending ring hollow but as I have always stated, these macro headwinds do not translate cleanly or easily into market strategies. Thus, even as I see this economic dissonance eventually resolving to the downside, I have put money to work in recent weeks. Opportunities will present themselves even in market downturns and I continue to focus on specific situation fundamentals, using the bigger picture to inform but not dictate my actions.

As always, YMMV.

Davy Bui

About the author:

Davy Bui
Ravi Nagarajan is a private investor and Editor of The Rational Walk website. Ravi focuses on applying value investing techniques to find securities trading well below intrinsic business value. Ravi has over 15 years of experience in the financial markets and started investing on a full time basis in 2009. From 1996 to 2009, Ravi held a number of technical and executive level positions in the commercial software industry. Ravi graduated Summa Cum Laude from Santa Clara University with a degree in finance. Visit his website The Rational Walk

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