What’s Up Is Up, What’s Down Is…Up

While Q1 GDP was unchanged, dueling headlines said corporate profits both rose and fell.

Story Highlights:

  • The BEA’s second estimate of Q1 GDP showed unrevised growth of 1.8%.
  • The BEA also released their Preliminary Corporate Profits report, with some news outlets saying profits rose, while others said they fell.
  • Both are right: Pre-tax profits were up, but post-tax profits fell.
  • But that says more about a complex tax code than anything else—break the data down, and you’ll see businesses are fine overall.

Tired of Oprah’s retirement to-do? You’re in luck! Thursday brought a nice distraction in the form of the BEA’s latest economic report.

Most attention-grabbing was the second estimate of Q1 GDP growth: 1.8% annualized—unchanged from last month’s advance estimate, though off consensus estimates of 2.2%. But while the headline number held steady, some components fluctuated. Household spending was revised down and imports revised up, but those detractions were offset by stronger than previously estimated business conditions. Business investment, inventory restocking and exports were all revised up.

Fine news, but more interesting to us was the BEA’s simultaneous release of US preliminary Q1 corporate profits data. Anyone surveying major news outlets would be forgiven for not knowing whether profits rose or fell. The Wall Street Journal, The Street and Bloomberg all touted an increase, while Reuters, the Chicago Tribune, the BBC and the Financial Post reported a decline. Weird, but then dueling headlines aren’t surprising in this environment—they’re right in line with the varied sentiment we’ve seen lately.

But who’s right? Well...would you believe both? The BEA’s report showed before-tax profits rose $21.9 billion (1.3%)—lower than Q4’s $38.2 billion jump but still growth. Yet the report also showed after-tax profits declined $11.6 billion (-0.9%), down from Q4’s $39.5 billion increase.

Turns out taxes paid on corporate income went up $33.6 billion, mostly due to changes in depreciation accounting. Exclude adjustments for inventory valuation and capital consumption, and profits jumped 6.3% pre-tax and 5.9% post-tax—on par with much of the last expansion. So between the pre-tax increase and those adjustments, US corporations made even more money than in Q4 2010. In fact, Q1’s annual rate of $1.7 trillion was the highest since 1947, when record keeping began. So, amid talk of slowing US GDP, corporate America is chugging along quite nicely.

But what of that pesky post-tax decrease? In light of other information in the report, it mostly speaks to the US’s overly complicated corporate tax code. The US has the developed world’s second highest marginal corporate tax rates—behind only Japan (who actually talked of lowering pre-earthquake). Yet there’s also myriad deductions and loopholes, so few major companies actually pay at those onerous rates. Now that might seem a benign contradiction, but consider the consequence: The complex code motivates corporations to allocate significant capital to tax that could otherwise be spent on hiring, R&D and/or expansion, which even most politicians seem to like.

Yes, Thursday’s battle of the headlines illuminates the need for a simpler (read: improved) US corporate tax code (and for the need to dig deeper than headlines). But there’s much more to glean from BEA’s reports! They also demonstrate how economic readings—even GDP and profits—rarely uniformly accelerate quarter after quarter. That’s not to say markets won’t stay choppy for now, but continued corporate profitability and economic growth should provide a nice tailwind over time.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.