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Taxes, profits, wages; breaking apart the mix
Simply Economics - December 1, 2017
By Mark Pender, Senior Editor



Corporate profits were one of the week's overlooked indicators but delving into the details of this quarterly report offers insights on both taxes and profits and also leads to another of the week's reports, personal income and outlays where wages and salaries are tracked. Other indications in the week include unusual news out of housing and disappointing news on November consumer spending, at least a portion of November's consumer spending.


The economy

Corporate profits, on which share prices are ultimately valued, haven't been showing anywhere near the growth of the stock market. First let's look at pre-tax profits which are the light blue area of the graph, at an annualized rate of $2.22 trillion in the latest data which are for the third quarter. This is just short of the $2.23 trillion peak in fouth-quarter 2014 after which the oil slump pulled the numbers back to the $2 trillion line. Pre-tax profits first peaked over $2 tillion in 2012 and really haven't expanded that much, only 10 percent over the past five years. Turning to the dark blue area of after-tax profits, they're doing no better and are also up 10 percent over this time, at $1.74 trillion in the latest data.


The green area of the accompanying graph is the difference between pre-tax profits and after-tax profits, coming in at a $476 billion annualized rate in the third quarter. Here too, flat is the theme with the gain over the past five years at about 7.5 percent. A sharp cut in corporate taxes could boost after-tax profits by $100 billion or more which is sizable of course, but would it be enough to justify ongoing inflows into the stock market? When keeping score in the unfolding tax debate in Washington, note that the latest anualized tax level ($476 billion) is equal to 21.5 percent of the quarter's pre-tax profits ($2.22 trillion).


Other data in the week included personal income and outlays where wages and salaries are tracked. This component is reported on a monthly basis and came in at an $8.43 trillion annualized rate in October. The 5-year growth rate here is more tangible but still modest, at 20 percent. Though this is mostly positive for workers the mismatch between wage growth and profit growth points to a squeeze underway for businesses and speaks to weak productivity which is one of economy's central problems right now.


Let's look at the government's fiscal 2017 which ended this last September to see how tax receipts play out month to month through the year. Corporate taxes, the blue area at the bottom of the graph, don't really start coming in until December with April and June also significant months. Individual taxes, the large green area, also rise in December and especially of course in April and make up the overwhelming share of the government's total receipts, at 48 percent in fiscal 2017 vs only 9 percent for corporate taxes (social insurance receipts, excise taxes and custom duties make up the balance). Compared to 5-year growth of only 7.5 percent for corporate taxes, individual taxes are up a very immoderate 40 percent, from $1.13 trillion in fiscal 2012 to $1.59 trillion in fiscal 2017. When it comes to the budget, individual taxes are the government's bread-and-butter category.


This year's spike in the stock market may be predicated to a significant degree on expectations for corporate tax cuts and their long-term effects but it's not based on any ongoing burst of growth. Yes, GDP has made the 3 percent grade the last two quarters but consumer spending hasn't been the spearhead. Modest to moderate has been this year's consistent theme of the Federal Reserve's Beige Book and this description fits two key consumer readings: personal income and spending. Widening out from wages and salaries and including other income like rent, interest and proprietor income, personal income is about double wages and salaries alone but is doing no better, up only 3.4 percent in the latest annualized data. Consumer spending has been doing better, at a 4.2 percent rate but still posing no threat of overheating.


Housing has also been far from overheating but not the last two new home sales reports where a breakout is underway. Sales of new homes, tracked by the blue line, surged 6.2 percent in October to a 685,000 annualized rate and a new expansion high. A downward revision to September was limited, holding at an unusual gain of 14.2 percent to a 645,000 rate which is now the second highest this cycle. For those wondering about a housing bubble, this sudden sales surge hasn't yet led to a price surge with the median price of new house, at $312,800, up only 3.3 percent on the year. The graph's green columns of existing home sales have yet to show anything like this kind of life though the week's data does include a hint of oncoming strength as the pending home sales index, which tracks initial resale signings, climbed 3.3 percent. Added to this is a sharp upward revision in the week to housing permits which jumped 7.4 percent in October to a 1.316 million rate. Indications are now in place that point to a substantial fourth-quarter contribution from the housing sector.


One area of the economy that has been surging all along is the labor market. The outlook for next week's highlight — the November employment report — is very positive and is based largely on low levels of jobless claims. Puerto Rico has been inflating recent claims totals but only to a limited degree, falling to 2,965 in the latest data for the November 25 from a post-hurricane peak at nearly 8,300 in early November. Before climbing, claims in Puerto Rico first fell following Maria's September strike as the unemployed, due to the destruction, were unable to file and the decline in the latest week suggests that worst is now behind. Total new claims fell 2,000 in the latest week to 238,000 with the unemployment rate for insured workers holding at a near record low of only 1.4 percent.


The week's last bit of economic news is unit auto sales and the first hard indication on consumer spending during November. The results came in at expectations with unit sales falling sharply to a 17.5 million rate after peaking at 18.6 million during the hurricane-replacement demand of September and October. Unit sales don't always track cleanly with dollar sales as measured in the retail sales report yet the results do confirm that consumer momentum isn't unlimited and they strongly indicate that motor vehicles will be pulling down on November retail sales.


Markets: How confident are you really?

Another report issued in the week was consumer confidence which can't stop rising, to 129.5 in November for a new expansion high. Optimism over jobs has been the major factor boosting the index but expected stock market gains are another as 46.0 percent of the sample see stocks rising over the next year, which is up 3.8 percent from October, and only 19.0 percent see the market going lower, down 3.7 percent. Such readings really offer contrarians the chance to test their theories. LIke two sides of a coin, note the close relation between consumer confidence and the stock market here represented by the Dow.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2016 24-Nov-17 1-Dec-17 Change Change
DJIA 19,762.60 23,557.99 24,231.59 22.6% 2.9%
S&P 500 2,238.83 2,602.42 2,642.22 18.0% 1.5%
Nasdaq Composite 5,383.12 6,889.16 6,847.59 27.2% -0.6%
Crude Oil, WTI ($/barrel) $53.71 $58.97 $58.35 8.6% -1.1%
Gold (COMEX) ($/ounce) $1,152.50 $1,292.60 $1,283.20 11.3% -0.7%
Fed Funds Target 0.50 to 0.75% 1.00 to 1.25% 1.00 to 1.25% 50 bp 0 bp
2-Year Treasury Yield 1.21% 1.74% 1.77% 56 bp 3 bp
10-Year Treasury Yield 2.45% 2.34% 2.37% –8 bp 3 bp
Dollar Index 102.26 92.76 92.9 -9.2% 0.2%


The bottom line

Economic conditions are solid but not other worldly like the stock market. The economy could definitely get a boost from a tax cut which however could very well in turn be offset, at least in part, by what appears to be a series of coming rate hikes by the Federal Reserve including one at this month's FOMC. Stocks are getting a lot of mileage from taxes, but the Fed looks to be a new front for the market.


Week of December 4 to December 8

Friday's employment report will be the week's economic focus and solid strength is the call, a return to normalcy after the disruptions of the hurricane season. The week opens with factory orders on Monday and another look at the durables economy which, outside of monthly swings, appears to be building steam. But the trade report on Tuesday could be reason for some concern as October's deficit, based on preliminary data, looks to have widened sharply to begin the fourth quarter. Service sector updates, which are usually strong, will also be posted Tuesday. ADP on Wednesday and jobless claims will offer last looks at the labor market going into November's employment report on Friday.




Factory Orders for October

Consensus Forecast, Month-to-Month Change: -0.4%

Consensus Range: -0.8% to -0.1%


Factory orders for aircraft and capital goods, which had been very strong in prior months, fell back in October and set up what is expected to be a 0.4 percent decline for the month's factory orders. But outside these factors, factory orders are likely to show strength and confirm expectations for fourth-quarter manufacturing strength.




International Trade Balance for October

Consensus Forecast: -$47.1 billion

Consensus Range: -$47.7 to -$44.0 billion


The international trade deficit is expected to widen sharply in October, to $47.1 billion from September's $43.5 billion in what would be a negative start for fourth-quarter net exports. The forecast is based on a sharp widening in October's trade deficit for goods where exports fell sharply and imports of consumer products jumped.


PMI Services for November, Final

Consensus Forecast: 54.7

Consensus Range: 54.7 to 55.1


PMI services slowed slightly in the November flash but details still held solid led by new orders and a 3-month high for employment. Both input costs and selling prices, in a special sign of strength, are increasing for this sample. The Econoday consensus is calling for no change from the flash, at 54.7.


ISM Non-Manufacturing Index for November

Consensus Forecast: 59.0

Consensus Range: 58.0 to 59.7


ISM non-manufacturing posted its best composite score of the expansion in October, at 60.1 for a peak last matched at the height of the prior expansion in 2004. New orders including export orders are unusually strong. Backlogs have been building and employment is at a 6-month high. Only limited slowing, to 59.0 from 60.1, is the Econoday consensus for November.




ADP, Private Payrolls for November

Consensus Forecast: 192,000

Consensus Range: 159,000 to 235,000


ADP made a good call back in October, looking for sharp but still limited bounce back for payrolls which were depressed by hurricanes in September. The consensus for ADP's November call is 192,000 vs ADP's October call of 235,000.




Initial Jobless Claims for December 2 week

Consensus Forecast: 240,000

Consensus Range: 234,000 to 245,000


Initial claims are expected to come in at 240,000 in the December 2 week vs 238,000 in the November 25 week. Data throughout this report are near historic lows and claims from Puerto Rico may now be coming down following Hurricane Maria.


Consumer Credit for October

Consensus Forecast: $17.0 billion

Consensus Range: $16.0 to $19.5 billion


Revolving credit has been on the rise which may be a positive for the holiday shopping outlook but a negative perhaps for credit standards. After increasing a sharp $20.8 billion in September, consumer credit is expected to rise $17.0 billion in October.




Nonfarm Payrolls for November

Consensus Forecast: 185,000

Consensus Range: 153,000 to 250,000


Unemployment Rate

Consensus Forecast: 4.1%

Consensus Range: 4.0% to 4.3%


Private Payrolls 

Consensus Forecast: 183,000

Consensus Range: 157,000 to 245,000


Manufacturing Payrolls 

Consensus Forecast: 20,000

Consensus Range: 10,000 to 20,000


Average Hourly Earnings

Consensus Forecast, Month-to-Month Change: 0.3%

Consensus Range: 0.1% to 0.4%


Average Hourly Earnings

Consensus Forecast, Year-on-Year Change: 2.6%

Consensus Range: 2.5% to 2.8%


Average Workweek

Consensus Forecast: 34.4 hours

Consensus Range: 34.4 to 34.5 hours


Hurricane effects are expected to be confined to September, when nonfarm payrolls rose only 18,000, and to October when they snapped back to 261,000. November's consensus is an intrend and still strong 185,000. The unemployment rate never showed much effect from the hurricanes, dropping a tenth in October to 4.1 percent where it is expected to hold in November. Moderate strength is expected for average hourly earnings, at a consensus 0.3 percent monthly gain for an improving 2.6 percent year-on-year rate. Other calls are for a 183,000 rise in private payrolls, another strong gain at 20,000 gain for manufacturing payrolls, and no change for the workweek at 34.4 hours.


Consumer Sentiment Index, Preliminary December

Consensus Forecast: 98.8

Consensus Range: 96.5 to 101.1 


The consumer sentiment index edged back in November but still came in at a very solid 98.5. The report notes strong certainty among consumers for gains in income and employment. A slight gain is the call for the preliminary December index to 98.8.


Wholesale Inventories for October

Consensus Forecast, Month-to-Month Change: -0.1%

Consensus Range: -0.4% to 0.4%


Wholesale trade inventories are expected to fall 0.1 percent following a decline in October's advance reading. Wholesale inventories had been climbing sharply in prior months.


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