Monday, August 23, 2010

Are Corporate Earnings Sustainable?

Last week, EconomPic showed the historically relationship between the treasury yield and nominal GDP growth. Below, we compare corporate earnings growth to the treasury yield over that same ten year window.

What we see is that earnings on a cyclically adjusted basis (smoothed per Shiller) have been growing faster than the broader economy for the past ten years.

My thoughts (as shared last month):
The important question is how these earnings have come about. We all know that recent earnings have ratcheted higher due to reduced costs (job cuts, lack of investment, cheap financing) rather than top line growth. In other words, executives for public firms have caught up with the "buy, strip, and flip" nature of private investors.
In addition, simple math proves that earnings cannot grow faster than nominal growth over the long term, as that would imply earnings at some point become larger than the economy as a whole (not possible as earnings are part of the economy).

In summary... expect earnings to be under pressure in the not too distant future unless there is surprise outsized rebound in the economy.

Source: Irrational Exuberance


  1. Is the chart title incorrect (it looks like the blue line is yield, not nominal GDP

  2. it was actually worse then that. i had uploaded the wrong chart (earnings growth vs. yield). now fixed...

  3. Thanks Jake. You managed to bring forward an incredibly important point and explain it very concisely.

  4. Jake,
    this post and the mortgage rate post will be all over the internets tomorrow I predict. Make sure you get credit and not ripped off like it has happened before!

  5. i'm used to it... just trying to spread the word!

  6. I would love to get ripped off, but thats just me!

  7. Hi,

    since the 70s we had a lot of adjustments in the GDP measurement. Substitution, Weighting, Imputations, and Hedonics. All that can´t be profits, but it is counted for GDP. So wouldn´t the chart look much worse in reality?

  8. Agree with your comments about cost cutting being the driver of profit growth recently. However, how do you factor in offshore earnings? The biggest companies and some down the food chain have figured out how to profit despite a given local economies robustness. Sure a bad US economy hurts but if you can offset some of it in China or Brazil then the link is broken, at least to a degree.