This Time, It Is Going To Be Very Different

The Federal Reserve today ended it’s meeting without raising the Fed Funds Rate.  As you can see by the chart below (Time-wise it reads from right to left), the Fed Fund Rate has been near zero for a long time.

So long, in fact that it has seen the peak of our most recent economic upswing (Much shallower than the last peak AND shorter in duration) and our return back to the shores of recession, all without a single rate hike.

Those that have followed my conversations in the past will recall that I firmly and unquestionably believe that the single greatest indicator to the health of the economy is Business Profits After Taxes, as reported by the Bureau of Economic Analysis.  This number cannot be as easily manipulated as GDP.

It does not give the false pretense of improvement because of government spending. Government spending does not produce profit.

What the number does reflect is after all is said and done is what have businesses earned that they get to keep from all of these efforts.   This is where the real motivation to grow, hire and expand your business originates from.

I’ve taken the data from the BEA (which anyone has access to) and created a spreadsheet with both 3 and five year rolling averages of the AGR(Annualized Growth Rates) for business profits after taxes.  This data is so simple to comprehend that I would even bet that you can see without highlighting it the last three recessions that we have had.  You can also see clearly when we exited those recessions.

And, if you look at where we are today, you understand what is about to occur.  Which brings us back to the Federal Reserve.  If you look at the chart carefully you can see that each time we were in a recession( and we admitted it), the Fed cut rates, which has the effect of giving businesses a boost to profits.

This time, it is going to be very different.  The Fed has no room to cut rates.  We are near zero already.  Business profits year over year have plummeted, and the Federal Reserve continues to tell us things are getting better.  Read their latest comments here:

https://www.scribd.com/doc/272962361/FOMC-July-Statement-Blueline

Do you think they are clued in?   I do not think so.  I think if they were, they would know that they are on the cusp of a major crisis.

There are a few more things I’d like to point out here.  The 7.5% line is the approximate level at which year over year profits need to rise in order to stimulate real economic growth.  Anything less and we contract, right-sizing the economy until we begin to grow again.   We have a tendency to always use a baseline of zero as the indicator that things are or are not improving.  This is not the baseline to use in most cases.

Three and Five year AGR for Business Profits After Taxes

Three and Five year AGR for Business Profits After Taxes

This data reflects the most recent data available (Four quarters ending 1st quarter 2015)  Business profits after taxes also represent all businesses across the US from mom and pop down the street to Apple and Amazon.

Were you to accept what I have written, and you agree that businesses do go in business to earn profits, and the goal is indeed higher profits year after year, then what needs to be done for a strong, healthy economy because rather clear.

1)  Create an environment for businesses where the regulatory and fiscal burdens are reduced-not increased- for all businesses.

2)  If new legislation is passed that reduces a company’s bottom line, do so knowing that it will indeed have a negative effect on both business expansion and job creation.  So make damn sure that the reason why you are doing it is worth it.

3) The longer business profits after taxes increase and stay above the 7.5% line, the stronger the recovery.  So it is in our best interest to try to promote that outcome rather than detract from it.  Too often governments see that improvement and decide that they can take some of those dollars with no ill effect.  They are wrong.

If you see the chart as I see it, then you will see what is coming.  Ask yourself what will accelerate profit growth for businesses over the next 1-3 years?  What is the catalyst?  And if the Fed cannot cut rates, how long will this next down turn last?

I encourage you to be prepared.  Yes the markets are near all time highs.  But do not be fooled.  Total dollars of profit by the Dow 30 companies are on track to drop more than 9% year over year.  Hard to spin that as a healthy and growing economy.  The smoke and mirrors are being supplied by-yep you guessed it- The Federal Reserve.  The low rates are fueling record share buybacks, increasing per share earnings and therefore share prices.  I believe that you will agree that this is not a positive chart.

Dow 30 Profits Analysis 20150717

The solution to what ails us is clear.  Government needs to reduce the burden they are generating for businesses, so that if the businesses can meet the market needs of customers, they have the potential for higher profits-not less.

Only then we will see the US economy have an opportunity to restore it’s economic engine to more than idle speed.

These are my opinions.  I would love to hear yours.  Please post or comment or email me any questions.

EJ

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About EJ Moosa

EJ Moosa believes that a smaller government is a more efficient government. He believes that better analysis leads to better solutions. A graduate of Georgia State University In Business Administration, EJ grew up in Cobb County graduating from Osborne High School and worked at several Atlanta companies including First Atlanta, IBM, and Six Flags over Georgia.

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