Hodge Nov 02 06

Global Profits View

Andrew Hodge

Global Interdependence Center

November 2, 2006

Why Look at BEA Profits?  Fits Profits into the big picture  US Profits + Other income = US GDP (roughly).  US GDP forecast models (based on BEA data) forecast profits including industry  Adjusted for under reporting—includes all private  Drives US investment.

 Foreign reported separately—only source  More reliable and consistent—tax based  Seasonally adjusted. Qtrs Lead Wall St YoY

www.bea.gov

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U.S. Economic Accounts 2005 share

100% 90% 80% 70% 60%

Profits 9% Depreciation 6% Net Interest 5% Non Corporate & other GOS

}

Investment 17% Gross Operating Surplus—(Capital Income) 36%

Government and Net Exports

13%

16% Taxes on Pdn

7%

50% 40% 30% 20%

Compensation 57%

Personal Consumption 70%

10% 0% Gross Domestic Income (GDI) www.bea.gov

Gross Domestic Product (GDP) 3

GDP share—profits vs wages

www.bea.gov

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Findings  US and global profits at or near 30 year historic peaks in share  Profits leveraged and volatile  Analyze Industry Trends  Foreign share rising  Lead Indicator? Use (real) profits/unit real GVA (BEA table 1.15)

www.bea.gov

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Profits more cyclically sensitive U.S. Economic Accounts 1400

1200

1000

800

600

400

200

0 1970-I

1975-I

1980-I

1985-I

1990-I

1995-I

2000-I

2005-I

BEA profits

www.bea.gov

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Leverage makes profits cyclical

 Financial leverage (Interest)

16 14 12 10 % of GDP

 Operating leverage (Depreciation —rises in recession)

8 6 4 2 0 1950

1955

1960

1965

1970

1975 Depreciation

www.bea.gov

1980

1985

1990

1995

2000

2005

Depreciation +Net Interest

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Differences with Wall St  BEA Coverage

 All US operations incl. private, and foreign owned.

Operating earnings only.  GAAP includes non­operating items like financing, capital gains/losses Bad­debt write­offs and pension adjustments.

 BEA Sources

 Tax based reporting, supplemented last two years with Census and industry data

 BEA Methods

 Current cost “real world” depreciation rates  Measurement consistent over time and across sectors  Inventory at current cost

www.bea.gov

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Data sources used to estimate profits Financial­Accounting Data  Census Bureau Quarterly Financial Reports (QFR) • Available quarterly, within several months of end of quarter • Cover manufacturing, mining, & trade—roughly 1/3 of profits

 Data from regulatory agencies & other sources used to supplement QFR data

Tax­Accounting Data  IRS Statistics of Income (SOI) Data • Corporate income­tax return (annual) data • Available with a lag of 2 years www.bea.gov

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BEA and Wall St profits NIPA and S&P Profits Trends

450 400 350

1Q 1990=100

300 250 200 150 100 50 0 1990

1995 S&P Operating EPS

www.bea.gov

2000 S&P Reported EPS

2005

BEA Profits from Current Production

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Why did Wall St drop even more?  Big trouble in the “non­operating” side. And some major revisions.  Write­downs (goodwill impairment)  Pension adjustments  Capital gains/ losses

www.bea.gov

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Industry analysis  BEA covers US operations only  Tax based Profits Before Tax with IVA is the preferred measure • Available quarterly (in final GDP release/3 mos. after quarter) • Over 20 industry groups

 Industry metrics include  Profits  Dividends  Depreciation/Leverage

 Can be forecast based on a Macro/Industry view

www.bea.gov

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Financial Surging­Nonfinancial Slowing 60 50 40

% YoY Growth

30 20 10 0 2002

2003

2004

2005

2006

-10 -20 Total Domestic

www.bea.gov

Financial

Nonfinancial

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The virtues of seasonal adjustment  Wall St reports vs year ago  The BEA reports seasonally adjusted Quarters. (sequential)  Seasonally adjusted sequential reporting will lead the yr­ago comparison

www.bea.gov

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Globalization: Rising foreign share of earnings 30.0

% of National Profits

25.0 20.0 15.0 10.0 5.0

20 05

20 00

19 95

19 90

19 85

19 80

19 75

19 70

19 65

19 60

19 55

19 50

0.0

Foreign Earnings share

p

Gross Foreign as % of National Profits

www.bea.gov

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Global Profits volatile: setting records 15

% of GDP

14 13 12 11 10 9 8 1980

1985

1990

1995

2000

2005

G-7 Profits % of GDP

www.bea.gov

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Contact Information

Andrew Hodge Head of Profits Research, BEA andrew.hodge@bea.gov 202­606­9761

www.bea.gov

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