ORLANDO, Florida, June 2 (Reuters) - Headwinds from
tariffs, bond yields and 'stagflation' are gathering force, but
corporate America could not be in better shape to face the
economic storm that may be building.
Data released last week showed that U.S. pre-tax corporate
profits fell $118.1 billion, or 2.9%, in the first quarter, the
fastest pace since 2020, suggesting companies are feeling the
pinch from tariffs even before they've properly started to bite.
After-tax profits fell 3.6%.
But any sense of alarm should be mitigated by the fact that
profits surged $205 billion, or 5.4%, the three months before.
The decline in the January-March period was simply normalization
on the back of a bumper quarter.
And on a year-on-year basis, profits were up more than 5%.
True, the next few quarters could get messy. If growth slows
or inflation starts to rise, corporate margins could get
squeezed, consumers may curb spending and companies could find
themselves with limited pricing power.
But zoom out, and the bigger picture suggests corporate
America has rarely been stronger.
Depending on how you slice and dice the figures, corporate
profits as a share of national output or income are still
extraordinarily high. In some cases, they're close to the
highest on record.
Consider pre-tax profits with inventory valuation and
capital consumption adjustments. These fell slightly to 13.0% of
GDP in the first quarter of this year, on a seasonally-adjusted
annual basis, but that was from a record 13.5% in the
September-December period.
After-tax profits dipped to 12% of GDP from 12.2% in the
final quarter of last year. Again, that was a small decline, and
it leaves after-tax profits still near the all-time peak of
12.8% of GDP recorded in the second quarter of 2021. The average
over the past 75 years is less than 7.5% of GDP.
To paraphrase former British Prime Minister Harold
Macmillan, corporate America has never had it so good. Which is
just as well, because headwinds are gathering.
DOMESTIC VS 'ROW'
One can debate how much any of the number of brewing risks
will land on the real economy, but companies could certainly
feel some pain if they end up facing the collective punch of
tariffs, weakening consumer demand, diminishing pricing power
and higher-for-longer interest rates.
"An increasingly fragmented environment means diverging
trends across economies. It's an environment ... that will
constrain profits at home and around the world," says Gregory
Daco, chief economist at EY-Parthenon.
Tariffs and protectionism will put the squeeze on global
supply chains and overall trade. It will be interesting to
observe how the divergence between domestically-generated
profits and earnings accrued from the rest of the world (RoW)
plays out in this environment.
Domestic profits account for the majority of total income,
of course, but that share has exploded recently. Or looked at
the other way, the share of profits from abroad has plunged. If
Trump's trade war succeeds in prompting U.S. companies to bring
more production back home, the 'RoW' footprint may shrink
further.
In the fourth quarter of 2019, just before the pandemic,
domestically-generated profits were around 75% of the $2.13
trillion total, on a seasonally-adjusted annual basis, and 'RoW'
profits accounted for a quarter. In the first three months of
this year, domestic profits accounted for 87.5% of the total,
and the share of profits from abroad had halved to 12.5%.
Corporate profitability is being tested. The aggregate
second quarter earnings growth forecast for S&P 500 companies
stands at 5.5%, according to LSEG I/B/E/S, down from 10.2% two
months ago. The 2025 calendar year earnings growth forecast has
shrunk to 8.3% today from 14.0% at the start of the year.
The challenges are mounting, but corporate America can face
them from a position of strength.
(The opinions expressed here are those of the author, a
columnist for Reuters)