Alhambra Investment Partners

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At Alhambra we begin with the belief that you are unique. And since unique situations require unique solutions the first step is to listen to you. There is no one-size-fits-all investment plan, so before we invest the first dollar we get to know you, your goals and your dreams. Next we compare your specific needs and requirements to determine whether active or passive investing is right for you and whether your plan should be strategic or tactical or both. Finally, we take our analysis and engineer a custom investment portfolio that matches who you. Alhambra investment decisions are based on our own extensive research and expertise. Our research staff has almost 100 years of combined market experience. The team drills deep into corporate data to find the smallest details that others miss, looking for true opportunity for our clients. The members of our team are highly respected in the financial industry and their insights are sought after by television business networks and radio programs. Their opinions and commentary are also widely quoted in financial publications as well as a multitude of internet outlets such as RealClearMarkets.com.

Inflation, Properly Defined

 

With the preliminary release of the quarterly GDP revision comes the BEA’s version of corporate profits. This is obviously different from EPS accounting that goes along with stock indices and various earnings growth measures as this macro view of profits encompasses a much larger business spectrum (though it does not include non-corporate business which is a pass-through component into personal income). From recent data it is clear that the US economy and its corporate enterprise segment have a profit problem.

ABOOK June 2015 GDP Profits AT

It isn’t clear at all on the chart above because that is only one version of corporate profits. Corporate Profits After Tax (CPAT) includes a whole host of factors including IVA and capital consumption that attempt to reconcile economic profitability from all that goes into tax returns and the like. From this starting point, however, the state of profitability does not look in any way to be a potential economic problem. Starting especially in 2002, CPAT took off and was only interrupted by the Great Recession.

Overall annual growth has come down recently but was nearly 10% in Q1 2015, which doesn’t seem to necessarily agree with a widening “slump.”

ABOOK June 2015 GDP Profits AT YY

If CPAT includes everything that goes into a bottom line, the major starting point is where the BEA classifies Profits from Current Production (PCP). This is, as the term implies, simply profits derived from actual business activity, including the IVA and CCadj, with the difference between them calculated tax liabilities. The PCP view of businesses is much more challenging, as is the relationship between the two.

ABOOK June 2015 GDP Profits CP YY

PCP has been largely stagnant since QE3 started; in the ten quarters since Q2 2012, PCP growth has averaged just 2.1% whereas the average was 13% in the ten quarters prior. CPAT has been continuously rising but PCP has not.

ABOOK June 2015 GDP Profits Ratio

In fact, when you compare the two the contours of this profit problem emerges. A great deal of profit growth appears to be derived exclusively from tax-based “stimulus”, especially in the aftermath of both the dot-com recession and Great Recession. While no business is going to be bothered about a reduced tax liability, that isn’t at all the same as gaining greater profit from actually taking part in business activity. Just because profits are rising due to a relatively lower tax bill there should be no expectation of a direct economic benefit, yet there is as part of orthodox theory.

As is clear in the chart immediately above, starting in 2002 (where a number of “stimulus” programs were conceived and executed) the growth rates between the two profit views becomes enormous – after tax, again, skyrocketed while actual profitability derived from the actual carrying out of business activities was somewhat less enthusiastic. That is good for one view of the stock market, but also begins to explain why the real economy and stock bubbles might so diverge (increasingly so).

ABOOK June 2015 GDP Profits All

This economy/finance split is even more pronounced when taking into account actual cash flow from operations. Cash flow (NCF) has lagged behind both means of profitability since the height of the housing bubble which suggests other accounting factors responsible for what may amount to an illusion of sorts. You would expect a rather close relationship between at least PCP and NCF and that was the case up until sometime in the mania portion of the housing bubble (with its emergence during the mania portion of the dot-com bubble).

ABOOK June 2015 GDP Profits CF PCP

On a strictly cash flow basis, US corporate businesses are especially struggling both in historical context and as a matter of “cyclical” misfiring.

ABOOK June 2015 GDP Profits CF YYABOOK June 2015 GDP Profits CF

There is nothing like this in the data series, where cash flow could stagnate either four or five years (depending on where you mark the peak; either Q2 2010 before that interruption in the middle of that year which precipitated QE2, or Q4 2011 and the first rumblings of the 2012 slowdown which brought on QE3 and QE4). From this perspective, the economic malaise of the past few years makes much, much more sense.

ABOOK June 2015 GDP Profits Recent All2

That leaves the corporate profit picture, once existing in good harmony and hierarchy, completely splayed apart by what is continuous artificial means of essentially faking a recovery. Cash flow fell behind all the way back at the end of 2011 while PCP slowed and then stagnated leaving just CPAT as denying anything economically amiss. How is that cash flow and profits could be so separated for four or five years?

The US economy’s profit problem isn’t necessarily the growth rate but the actual meaning embedded within each segmented component and how each is being almost manipulated by inconsistent factors. In other words, there used to be an established relationship which would produce a cohesive picture of US business as it went about the profitable business of business. Now, in the age of “stimulus” activism all over the place, we have a massive difference between profit growth due to organic expansion and profit growth due to government agencies trying to engineer one, but failing to do so.

We can also add ZIRP and QE to this narrative, as well as the “dollar”, all of which boost profits from non-business activities by reducing interest costs and changing accounting; these aren’t apparent here, but the amount of profit growth derived strictly from interest “savings” is large, and like taxes does not actually encourage more organic business activity on its own. Orthodox economic theory takes profits as generic like “aggregate demand” in that all that matters is a rising number without any account for how that number rises. No business is going to go out and hire more workers just because of a lower tax bill, reduced interest on its bonds or the high variation of the “dollar” exchange.

What those factors amount to is a form of “inflation” where the dollar-value of profit is divorced (often intentionally) from the actual matter of cash flow. Economists and stock analysts look upon rising profits as a key measure of economic success and health when, apart from generic inclusion, the means by which each component are taken is far more important to the macro view. If profits are gaining purely from lower taxes and interest but falling even slightly from actual production then you can be certain the latter is affecting the economic margins far, far more than the artificial former. Thus economists can see rapidly rising profits and think a rapidly rising economy when cash flow reveals that to be more artificial than anything else – that is, actually, inflation properly defined, changing nothing but the standard of measure.

There is hidden inflation almost everywhere these days even if and when it does not have anything to do with consumer prices. Orthodox economists have convinced the worold of the exclusivity of the CPI as it relates to inflation, but consumer prices are just one potential element – even asset bubbles constitute another extreme form where the standard of measure is debased well away and apart from the base economy. The profit problem in the US ends up with the same type of disconnect and discord, where, as with rapidly rising consumer inflation, it may look like the economy is moving sturdily forward in the business sector when, in fact, the opposite may be the case (as now). Under rational expectations, that is sometimes all that matters (to the orthodox view) as this form of inflation, the profit problem, actually reinforces the asset inflation; one view of it (asset inflation) is “valued” by the other (profit inflation) leaving the rest of the economy to carry out a steadily eroding baseline of attrition.

ABOOK May 2015 Sentiment FT Jobs