Profits High, Investment is Not

The latest data on corporate profits show further gains to new record peaks, with the second quarter showing $2.11 trillion (annualized).  Before the Great Recession hit in 2008, the prior record high profits were $1.78 trillion.  The runaway profits are one key reason for the high stock market valuations.  An ultra-loose monetary policy has forced cash to yield zero, so the money has been chasing bonds and stocks, and to some degree real estate.

The high profits unfortunately have not yet translated into higher business spending.  Private business spending (which is classified more formally as non-residential fixed investment in GDP accounting) was scratching out only $1.99 trillion in the second quarter.  In most periods, business spending would actually be comfortably higher than corporate profits since much of the spending also comes from borrowing from banks and by issuing corporate stocks and bonds, as can be seen in the chart below.  For example, prior to the recession, business spending was $2.3 trillion (while profits were $1.8 trillion).  But that is clearly not the case today.  Have private businesses simply gone on strike?

The ‘fiscal cliff’ possibility at the start of next year (unless a new federal budget can be passed) is not inspiring businesses to spend now.  The added costs from healthcare legislation and/or new regulations may also have dampened enterprising spirit.  Or it could simply be that businesses are looking for increased aggregate macroeconomic demand – from say, additional federal government spending, particularly related to investment in infrastructure.  Simply, if business spending were to return to normal in relation to corporate profits, then the economic growth would be much faster and job creations much more robust.

Another abnormal aspect of the current profits data is that the private sector wages-and-salaries have not risen commensurately.  Wages-and-salaries are much more stable while profits are subject to big swings so the ratio of the two will be a bit volatile over the short-term.  But note the persistence of wages-and-salaries bouncing along the bottom in recent years.  The persistent high unemployment rate has no doubt dampened wage growth prospects.