Profit Margins

The Lehmann Letter ©

Why is the stock market climbing although the economy is slack?

Record profit margins should be part of any answer.

Think of profit margins as the ratio between the price of the product divided by the cost of producing it. If the number rises, profit margins are rising as the gap between price and cost grows. If the number falls, profit margins are falling as the gap shrinks.

The chart shows profit margins for the whole economy. You can see that they now stand at a post-World War II high.

Chart 2.3 Profit Margins

(Click on image to enlarge)



Recessions shaded

Business now enjoys this good fortune because the cost of producing each unit of output has fallen while prices have held steady. During the recession employers reduced their workforces more than output fell. The employees who survived the mass layoffs now produce more per hour of work because workforce reduction exceeded output reduction. That means less labor time is required to produce each unit of output. Consequently unit labor costs (the cost of producing a unit of output) have fallen. The chart shows record profit margins as prices held steady while costs fell away.

But record profit margins by themselves can’t keep boosting total profits. Growing profits also require growing sales volume. (Total Profits = Profit Margins X Sales Volume) That’s why the economy’s recovery and improvement are also important.

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2010 Michael B. Lehmann

Weekly Review

The Lehmann Letter (SM)

The release of three major indicators made this a big week for real estate: Housing starts, existing-home sales and new-home sales.

Today the Census Bureau announced 288,000 new homes sold in August:

http://www.census.gov/const/newressales.pdf

That number shows no sign of recovery.

But it was yesterday's release by the National Association of Realtors of August's existing-home data that was a real eye catcher: 4.1 million following 3.8 million in July.

Existing Home Sales

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Recessions shaded

If you plug those numbers into the chart it looks like a double dip. That's because the tax credit artificially inflated Spring sales, which then plunged with the tax credit's expiration.

But keep your eye on the chart. We are now hovering around 4 million sales per month, a figure lower than any during the depths of the recession. There is no sign of recovery here.

Finally, the Census Bureau also announced today that new orders for nondefense capital goods were flat in August:

http://www.census.gov/manufacturing/m3/adv/pdf/durgd.pdf

That's an important barometer for the direction of business capital expenditures. It's stuck in a rut, too.

It was not a good week.

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2010 Michael B. Lehmann

August Housing Starts

The Lehmann Letter (SM)

This morning the Census Bureau reported that construction began on 598,000 new housing units in August and revised July's starts to 541,000:

http://www.census.gov/const/newresconst.pdf

The Bureau's press release said this was a gain of 10.5% and also said that August's figure was 2.2% ahead of July 2009's 585,000 level.

Housing Starts

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Recessions shaded

The chart puts these data in perspective. You can see that housing starts have been hanging out at 600,000 (plus or minus) for over a year. That's lower than any of the brief troughs of earlier post-war recessions. Today's numbers are so low that monthly fluctuations can appear large in percentage terms. We have got to break out of this range, say to one million or so, in order to claim any true improvement and an upward trend.

As yesterday's letter said: "(Housing starts) are important because residential real estate was the recession's ground zero. We can't have a robust recovery and expansion until residential real estate returns to health."

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2010 Michael B. Lehmann

This Week

The Lehmann Letter (SM)

This is a big week for housing data: On Tuesday and Friday the Census Bureau releases its reports on housing starts and new home sales, while on Thursday the National Association of Realtors announces figures for existing-home sales.

They are important because residential real estate was the recession's ground zero. We can't have a robust recovery and expansion until residential real estate returns to health.

But the building and bursting of the recent real-estate bubble created a new kind of recession. This recession did not flow from rising inflation and rising interest rates. Those past recessions were easily remedied by policies that generated falling inflation and falling interest rates. Low rates meant more borrowing and spending and a snappy recovery and expansion. This time we had an asset inflation followed by asset deflation. Now household balance sheets are compromised by scarce liquidity and falling equity. Low interest rates can't encourage households to buy new homes. They don't have the wherewithal and they remain poor risks.

As a result the asset deflation created both supply and demand problems. There are too many homes in foreclosure adding to the glut of unsold homes. At the same time households can't or won't buy new homes because their finances are too insecure.

New Home Sales

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Recessions shaded

The chart is worth a thousand words. You can see the boom and bust, and you can see that new-home sales have been hanging out at a depressed 400,000 for the past year. That figure must increase by 50% to 600,000 before we can claim robust recovery and expansion. But July sales fell to only 276,000. On Friday we'll know August's sales figure. Let's hope it's headed sharply north.

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2010 Michael B. Lehmann

Payments Deficit

The Lehmann Letter (SM)

In a further endorsement of the economic recovery, yesterday the Commerce Department announced that the U.S. International deficit on current account had risen from $109.2 billion in the first quarter to $123.3 billion in the second quarter:

http://www.bea.gov/international/bp_web/simple.cfm?anon=71&table_id=1&area_id=3

This may seem paradoxical: How can a growing balance of payments deficit signal a growing economy?

The chart serves to deepen the mystery: Each recession (gray vertical bar) appears to have reduced the deficit (the line climbs back up), while expansions have grown the deficit (the line continues south).

That's because the balance of trade drives our balance of payments. In recession our imports drop because falling incomes reduce expenditures on foreign as well as domestic goods. Consequently our balance of payments improves as we spend less overseas. When economic recovery and expansion bring growing incomes and increased expenditure at home and abroad, our balance of payments deteriorates as we purchase more from the rest of the world.

Current Account

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Recessions shaded

You can see from the chart that recent developments confirm this. Our balance of payments deficit dropped from over $200 billion per quarter to less than $100 billion in the course of the recent recession. Now the deficit is growing again as the economy and incomes recover and we purchase more from the rest of the world.

The chart also reveals the unmistakable trend over the past quarter century: The long run deterioration in our balance of payments as our purchases from the rest of the world grow. The recent recession provided a brief interruption in a disturbing trend. Now, as the economy gains momentum, you can expect the balance of payments deficit to deteriorate further and reach record levels once again.

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2010 Michael B. Lehmann

Industrial Production Grows

The Lehmann Letter (SM)

Today's Federal Reserve report on industrial production and capacity utilization was encouraging: http://www.federalreserve.gov/releases/g17/Current/default.htm

Both continued to grow in August, building on a year of recovery and improvement for manufacturing, mining and public utilities. That's good news.

Capacity Utilization

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Recessions shaded

Capacity utilization stands at 74.7%. That means that industry now produces 74.7% of the maximum it could produce. Round that number to 75% and plug it into the chart, and you could say that industry is making a snappy recovery. Capacity utilization has improved by over 5% from its recent trough during the worst post--World War II recession.

But the recovery has slowed in recent months. Capacity utilization was 74.0% in May, so that we've gained less than 1% over the past quarter year. You can see from the chart that we have to push our way back to at least 80% to claim that industry is thriving once again.

What can be done to accomplish this? Aggregate demand must recover and thereby provide a market for the goods industry produces. Residential construction and auto sales are the best simple measures of demand's strength. Think of all the lumber, steel, glass, rubber, cement and other materials these industries consume directly. And then think of all the furniture, furnishings, heating and air conditioning units and kitchen and laundry appliances that go into new homes. That gives you an idea how strongly industry's wagon is hitched to building's and autos’ horses.

New home-sales and home-building data will be out soon. We'll take a look at that to gauge the overall economy's health.

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2010 Michael B. Lehmann

This Week

The Lehmann Letter (SM)

On Wednesday the Federal Reserve will release this week's most important economic data: August industrial production and capacity utilization figures.

Much hope for the recovery relies upon an industrial rebound. Businesses have improved their profit margins, but sales must also grow for earnings.' continued expansion. Rising capacity utilization signals that industry is using a greater share of its plant and equipment in order to meet a larger volume of orders. This is good news by itself, but also may signal industry's need to invest in additional plant and equipment if capacity utilization rises steeply. That would help the construction sector and heavy machinery and equipment manufacturers.

Capacity Utilization

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Recessions shaded

The chart reveals how badly industry tumbled during the recession. It also shows the beginning of a rebound. Keep your eye on capacity utilization over the coming months. If the rate climbs past 75% and up toward 80%, that's a good sign that we're heading out of the doldrums.

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2010 Michael B. Lehmann

Strong Sales

The Lehmann Letter (SM)

Today the Census Bureau reported strong sales gains across a broad swath of American industries: http://www2.census.gov/wholesale/pdf/mwts/currentwhl.pdf

That's good news for our economy's recovery.

Businesses also continued to rebuild inventories while they maintained a low inventory/sales ratio. That's also encouraging because it reverses a development that dragged us into recession.

Here's why. Manufacturers' sales collapsed as the recession took hold. To make matters worse, inventories of unsold goods piled up on their shelves. The inventories/sales ratio climbed as sales plunged and inventories rose. Manufacturers brought the situation under control by slashing production by an amount greater than the sales drop, thereby bringing the inventories/sales ratio back down to normal levels. That was an important cause for the economy's rapid descent into recession and the equally rapid rise in unemployment.

Businesses did not resume strong manufacturing production until they had liquidated excess inventories. Today's report shows that this process is continuing as sales and inventories build once again while the inventories/sales ratio remains low after the inventory work off. This reversal of inventory liquidation, and the consequent rebound of manufacturing production, is an important ingredient in the economy's recovery.

But it won't be sufficient for a complete comeback or for the return of full employment. That will require stronger signs of life in demand for new housing and autos. Let's keep our fingers crossed.

© 2010 Michael B. Lehmann

No Double Dip Yet

The Lehmann Letter (SM)

Last week this letter urged readers to follow residential construction and auto sales for a clue on the economy's direction.

You already know about the weakness in housing. So let's examine new-vehicle sales.

The Commerce Department reports 11.4 million new-vehicle sales in August at a seasonally-adjusted annual rate. (See the end of this letter for instructions on retrieving the data.) The report also reveals that sales have been flat in the 11-million range for about half a year.

Much has been said about the auto industry's rebound. Profits have recovered and General Motors will soon return to private ownership after a spell under the wing of the federal government.

New-Vehicle Sales

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Recessions shaded

But the chart makes clear that a profit rebound is not necessarily a sales rebound. We have not returned to the 16-17 million range the industry enjoyed before the bubble burst.

In a way, this performance is a metaphor for the entire economy. Profits are back while the economy isn't.

That does not mean we are falling into recession. But it does mean that we are, at least for the time being, stuck on a low plateau.

New-vehicle sales won't send a signal that the economy has recovered until they grow back toward the 15-million range.

(To examine the data on new-vehicle sales……..

Go to http://www.bea.gov/ and then

Step 1: Click on "Gross Domestic Product" under "National"
Step 2: Scroll down and click on "Motor Vehicles" under "Supplemental Estimates"
Step 3: Save to your desktop as an Excel file and then open the file
Step 4: Click on the "Table 6" tab at the bottom of the page
Step 5: Look at column I (Light Total) and scroll down for the latest data)

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2010 Michael B. Lehmann

Not Yet Robust

The Lehmann Letter (SM)

Today the Bureau of Labor Statistics reported that the economy lost 54,000 jobs in August:

http://stats.bls.gov/news.release/empsit.b.htm

The stock market interpreted the report as good news because the private sector gained 67,000 jobs while government jobs fell by 121,000. The reasoning went like this: It's good that the private economy is gaining jobs, even while the Census continues to shed jobs, because it's the private sector that must recover.

True enough. But keep in mind that we want the economy to truly recover, not merely avoid another recession.

Job Growth

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Recessions shaded

The chart clearly illustrates the recession's damage to the labor market. At one time we were losing well over half a million jobs a month. Then we recovered into positive territory. But job losses recently reappeared as the Census shed workers.

Here's the point: The economy has to add 250,000 jobs a month to successfully drive the unemployment rate downward. That rate is now stuck between 9% and 10%. Those are not recovery numbers.

We need positive strength, not just the absence of weakness.

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2010 Michael B. Lehmann

September Publication Schedule

The Lehmann Letter (SM)

Today’s positive report on manufacturing from the Institute of Supply Management gave the stock market a boost. But it’s positive news from housing and autos that will signal the economy’s escape from its current morass.

• Here are the key consumer-demand indicators we'll examine and the September days and dates on which we can expect them to appear. They will give us up-to-the-minute information on demand's recovery.

Source (* below)……Series Description……Day & Date

BEA….New-vehicle sales…...(Approximate).Wed, 8th

Fed………..Consumer credit…...(Approximate).Wed, 8th
Census……….……..Housing starts………….Tue, 21st
NAR………………Existing-home sales…….Thu, 23rd
Census…………..New-home sales………...Fri, 24th
Conf Bd………….Consumer confidence….. Tue, 28th

• Production, employment and capital expenditures are important, but they’re not likely to lead the charge. Here’s what to watch.

Source (* below)……Series Description……Day & Date

Quarterly Data

BLS…………..Productivity…………….Thu, 2nd

BEA………..….GDP…………………….Thu, 30th

Monthly Data

ISM……….Purchasing managers’ index…….Wed, 1st

BLS…………………….Employment………… Fri, 3rd
Census…………………...Inventories……….. Fri, 10th
Fed……………..Industrial production……….Wed, 15th
Fed…………….Capacity utilization………….Wed, 15th
BLS………………….Producer prices……. Thu, 16th
BLS………………….Consumer prices….….. Fri, 17th
Conf Bd……….Leading indicators……….Thu, 23rd

Census………….Capital goods………….. Fri, 24th


* BEA = Bureau of Economic Analysis of the U.S. Department of Commerce
* BLS = Bureau of Labor Statistics of the U.S. Department of Labor
* Census = U.S. Bureau of the Census
* Conf Bd = Conference Board
* Fed = Federal Reserve System
* ISM = Institute for Supply Management
* NAR = National Association of Realtors

© 2010 Michael B. Lehmann