Profits declined and the market rose. What's going on?

July 21, 2023

There's a meme circulating that corporate profits are surging. This is easy to look up. In fact they declined in Q1 2023, falling by 5.9%. You can see a graph of them here.

But wait, you ask, didn't we just have the biggest 6-month start to the year of the Nasdaq in its 52 year history, bigger even than the illustrious dot-com bubble? Haven't U.S. markets shrugged off recession talk, relentlessly pushing upward? How does that jive with falling profits?

Remember that markets look forward. In 2021, markets anticipated the profit surge of 2022 and rose. In 2022, they saw a slowdown in profit coming in 2023, and fell. Now they are indicating that they expect profits to rise.

Businesses and consumers face new issues during periods of price instability that affect profits.

For example, during inflationary environments consumers lose track of where prices should be. You buy a little iPhone widget online and you don't know if the reference price should be $8.99, $9.99, or $11.99. Those are quite different proportionally, but you've lost your anchor because all prices are changing so fast. The seller sometimes uses this effect to raise profits.

Businesses in a period of price instability try to get in front of the inflation curve. If you have to commit to orders in advance, or you have a long supply chain and prices are moving higher, you try to pre-jump to make sure that you don't get caught in a loss scenario. This pre-jump starts to ripple through the economy as others pre-jump. While you end up with a lot of jumping going on, it's far from a party. The business's profits may end up higher than expected, or lower. It's hard to predict.

Profits fairly earned are a good thing (excluding, for example, monopolistic behavior). Profits create the incentive to invest and they provide compensation for risk taken. If they start to rise to an unusual level, they rapidly attract competitors trying to take those profits down through lower pricing or innovative solutions. This ebb and flow is central to capitalism, and it drives enormous value through to the end consumer. In some industries, like aviation, almost all of the aggregate benefit of the industry has flowed to customers, leaving investors with no returns.

If you're interested...

To see who is dominating the profit race by sector of the economy, click through to this chart. There are some interesting tidbits, like Home Depot made more profit than Wal-Mart, and Netflix took the crown in media. Keep in mind that it is easier to distort profit figures with accounting techniques than revenue figures.

Dan Cunningham