Corporate Profits -- Longer Term

The recovery of corporate profits is ending the large rebound, bounce back phase which started
in early 2009. Profits are now entering a phase where strong growth momentum can occur, but
is far less assured.

Profits tend to expand strongly in the wake of a depression or deep recession as sales recovery
and cost cutting produce cash flow that rapidly moves up to exceed the fixed cost burden. The
current earnings recovery has only been exceeded in momentum by the immediate post WW2 
period,when the economy moved exceptionally easily into peace time growth.

Normally, it is wisest to view a profits recovery in a time frame of 4-5 years off the cyclical
trough. That well established rule of thumb would put the peak of the current recovery / expansion
out to somewhere over 2013 - 2014.

Profits can expand out past the 4-5 year frame if certain important conditions are met. The most
important factor for a long run of profits growth is the balance maintained between economic
supply and demand. One main reason why  many profit recoveries have not lasted beyond
the 4-5 year time frame is that cycles in the growth of capacity do not match up that well with
the growth of demand. Capacitiy growth cycles tend to run for longer periods of time, and,
periods of weak capacity growth also tend to run for fairly lengthy intervals. The last long
period of relatively strong capacity growth lasted from 1992 through 2001. Since then, the
US has been in a period of weak capacity growth, including a net shrinkage of capacity over
the past 2 years. Given how technology and depreciation schedules move along, I think the
US is due for a significant makeover looking out through 2015.

The other critical factor in the recipe for a lengthy run in corporate profits growth is the
avoidance of a credit crunch. Looking back, I regard the tightening rounds in monetary
policy in 1994 and again over 2000-2001 as being too extreme given the superb balance
then extant between economic supply / demand. Looking forward, the Fed has to maintain
a better balance between money and credit growth if It is to foster a lengthy recovery /
expansion period.

So, looking ahead, you should watch not just monetary policy but the development of capital
spending as the recovery progresses. And, by capital spending, I mean not just equipment
and machinery, but new green field development as well. Right now, and measured yr/yr,
production growth is far outstripping capacity growth. If this condition obtains once the US
factory operating rate exceeds 80%, then we can expect a shorter, more normal cycle of
profits growth.

Fed's famous "gap" charts for production, capacity, cap. uty%. Charts