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Submitted by Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein

Operating profits for the overall economy have been essentially flat since 2014. Yet, during the same 5-year period operating profits for the S&P 500 companies are estimated to be up by a third.

Taken at face value, the profits data paints a picture of rising earnings for the companies that comprise the S&P 500 index while profits for millions of other firms are stagnant, if not contracting. How can that be? Are the earnings of S&P 500 companies “real” or are accounting gimmicks inflating them?

According to corporate profit data from the Bureau of Economic Analysis (BEA) operating profits for all US corporations (large and small and public and private) totaled $2.113 trillion in Q2 2019 essentially unchanged from the 2014 full year profit figure of $2.120 trillion.

Over the same 5-year period, the operating profits of S&P 500 companies have increased from $1.004 trillion in 2014 to an annualized estimated figure of $1.333 trillion in Q2 2019, and increase of 33%.

Both estimates of profits calculate earnings as the difference between receipts and expenses. Yet, the profit reports are based on two different accounting frameworks, financial and tax accounting.

Companies’ use financial accounting to report their results, while tax accounting results is the primary source for the GDP measure of profits. As a result, differences between the two profit measures can result from the timing of when receipts and expenses are recorded, as well of what is included and not included in receipts and expenses.

For example, the GDP gauge of operating profits adjusts for misreported and/or overstated measures of current income. Income or losses derived from capital sales are not part of the GDP measure of profits because they reflect the sale of existing assets and GDP is only measuring the profits from current production, and not the change in the valuation of items that were produced in previous periods.

Yet, S&P 500 profits, which are based on a financial accounting basis, do include income derived from capital sales, and other financial flows and adjustments as well.

At the currently reported levels for Q2 2019 S&P 500 profits amount to a record 63% of overall operating profits for all US companies. In the past 30 years there is only one other period when the share of S&P 500 earnings topped the 60% level. That occurred in the late 1990s when the large gain in reported S&P 500 profits was largely driven by capital gain income. And, during that period the GDP measure of operating profits followed a similar pattern to that of 2014 to 2019—flat to slightly down.

Corporate profits are an important measure of the economy’s overall performance as well as benchmark for the financial health of the corporate sector. The overall profit data raises questions about the general health of corporate sector. Moreover, the relative surge in S&P 500 earnings appears to be driven not by core operations and the experience of the late 1990s would argue that they unsustainable in their current form.

As month-end looms, demand for dollar liquidity is accelerating dramatically with today’s Fed operation oversubscribed – with around $92 billion of demand for The Fed’s $75 billion offering…

Source: NYFed

This is the heaviest demand yet for this new Fed liquidity spigot…

As we noted previously, some banks appear to have been simply waiting to get closer to the quarter end before tipping their cards: after all, just like the Discount Window, the repo operation has become the modern “stigmatizing” equivalent, and if reporters or clients get a whiff that a bank is in a dire liquidity state, the consequences could be dramatic.

Never mind though, it’s probably all transitory.

Iran has again signaled its readiness to come back to the table, even if it means potentially pursuing the new ‘Trump deal’ — after the president unilaterally withdrew the US from the 2015 nuclear deal in May 2018. It’s possibly the most the Iranians have been willing to compromise yet, considering previous statements have emphasized a full return of all parties to the original JCPOA. 

“If the sanctions are ended and there is a return to the (nuclear) accord, there is room for giving reassurances toward breaking the deadlock and the President (Hassan Rouhani) has even a proposal for small changes in the accord,” an Iranian government spokesman, Ali Rabiei, said on state TV Tuesday.

This also comes after the UK Prime Minister Boris Johnson has urged Iran as well as his European allies to back a new “Trump deal” this week in what was also a change in course for Britain. “If it was a bad deal — and I’m willing to accept that, it had many, many defects — then let’s do a better deal,” the prime minister told NBC News. 

Previously Trump has said he wants to start over, calling the Obama-brokered 2015 deal a failure:

“This deal if I win will be a totally different deal. This will be a totally different deal.”

However, based on the latest tweets by Secretary of State Mike Pompeo, it doesn’t look like Washington is ready to give up sanctions, a tall order for this administration or sanctions addicted Washington in general.

Iran remains the greatest threat to peace & security – that has not changed. We must work together, using all the tools at our disposal, to bring stability and prosperity to the Middle East & deny Iran the resources needed to engage in malign behavior around the world.

— Secretary Pompeo (@SecPompeo) September 25, 2019

In a follow-up tweet he stated that Iran must not be allowed to continue its destructive behavior and suggested for the sake of the Iranian people and the world, the UN Security Council has a vital role to play in ensuring the UN arms embargo on the world’s top sponsor of terrorism.

But again it’s the first time the Iranians have proposed willingness for “small changes in the accord” — which means they could be ready for something new, potentially leaving the JCPOA behind, as Trump has demanded all along. 

Washington’s blind commitment and addiction to sanctions though, will likely remain the insurmountable obstacle to any breakthrough leading to new talks. 

Authored by Charles Hugh Smith via OfTwoMinds blog,

The price of this “solution” – the undermining of the financial system – will eventually be paid in full.

The financial storm clouds are gathering, and no, I’m not talking about impeachment or the Fed and repo troubles–I’m talking about much more serious structural issues, issues that cannot possibly be fixed within the existing financial system.

Yes, I’m talking about the cost structure of our society: earned income has stagnated while costs have soared, and households have filled the widening gap with debt they cannot afford to service once the long-delayed recession grabs the economy by the throat.

Everywhere we look, we find households, enterprises and local governments barely able to keep their heads above water–in the longest expansion in recent history. This is as good as it gets, and we’re only able to pay our bills by borrowing more, draining rainy-day funds or playing accounting tricks.

So what happens when earned income and tax revenues sag? Households, enterprises and local governments will be unable to pay their bills, and borrowing more will become difficult as the financial markets awaken to the re-emergence of risk: as shocking as it may be in the era of Central Bank Omnipotence, borrowers can still default and lenders can be destroyed by the resulting losses.

The era of Central Bank Omnipotence has been characterized by two things:

1. A disconnect between risk and return. Since “central banks have our backs,” risk has been vanquished, and since central banks socialize losses by bailing out corporations and banks who gambled and lost, then the financial Oligarchs have been free to ignore risk since the Federal Reserve has implicitly guaranteed returns will always be secured by Fed backstops, market interventions, etc.

2. Costs have been ignored because “we’re all getting richer” via asset bubbles. Your healthcare insurance just doubled in a couple of years? Forget it, Pal, that’s chump change compared to the big-time gains in the value of your house and 401K stock holdings. This is the wealth effect: even as rising costs consume earned income, we ignore this financial erosion and borrow and spend more because we feel richer when we look at our home and stock valuations.

In other words, the wealth effect has been deployed to paper over the enormous structural gap between income and expenses. The wealth effect doesn’t just affect households: rising real estate valuations have boosted local government tax revenues, and small businesses have been buoyed by the spending of the top 20% who own 93% of the stocks owned by households and who have seen their homes soar in value. (Note that the top 5% own 71% of the stocks; the top 10% own 84%.)

But asset bubbles always pop, and once they do, the wealth effect reverses and people feel poorer as the value of their homes and portfolios decline. They borrow and spend less, and all the capital gains that boosted local tax revenues dry up, too.

Here’s reality: wages haven’t kept up with expenses. This chart displays healthcare costs, but rent, higher education, childcare, etc. have similar asymmetries.

Not to pick on these households, but they are representative of the enormous asymmetry between stagnant income and rising costs, and of the “solution”: debt, and lots of it.

I was surprised to find such an honest account in the mainstream (i.e. cheerleader of “good news”) Wall Street Journal:

Families Go Deep in Debt to Stay in the Middle Class
Wages stalled but costs haven’t, so people increasingly rent or finance what their parents might have owned outright Median household income in the U.S. was $61,372 at the end of 2017, according to the Census Bureau. When inflation is taken into account, that is just above the 1999 level. How households earning $61,000 can acquire cars costing half their gross income is a story of the financialization of the economy.

More accurately: financialization is the result of the cost structure pulling away from our ability to pay our expenses with earned income. The only way to enable costs to continue soaring far above our ability to pay them is to financialize the economy, making debt the core mechanism to pay the bills, and asset bubbles the core mechanism to create phantom collateral to support the skyrocketing debt.

Here’s the problem with reducing the cost structure to levels we can actually afford: all the fat in our system is screaming that it’s bone. The slightest reductions trigger titanic lobbying by whatever group of insiders or vested interests will bear the brunt of the cuts.

This leaves politicians with one easy way out: borrow enough money to satisfy the demands of every constituency, every clique of insiders and every vested interest. Rather than re-aligning costs with our ability to pay, we’re going to use debt to keep all the constituencies happy.

The price of this “solution”–the undermining of the financial system–will eventually be paid in full to the detriment of everyone, including all the layers of productivity-killing fat that proclaimed themselves essential bone.

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