The so-called gap between hard and soft data in the US could reflect misplaced optimism over the Trump administration. There is an alternative explanation. The hard numbers – notably GDP – may be wrong and are not capturing the improvements in the economy underway. Friday’s release from the BEA was a case in point. The third estimate for GDP included the latest estimates for profits. Total corporate profits (with IVA and CCAdj) increased 0.5% q/q in Q4 and 9.3% y/y. Corporate sector cash flow has rebounded, rising 10.9% y/y. However, profit margins fell again. The first indicator is likely to be more reliable: it is a hard figure published in dollar terms, which suggests companies are right to be more optimistic. The economy had significant momentum before Mr Trump’s election victory on November 8th.
By contrast, profit margins are an implied index, which is calculated using the productivity data. While cash flow is close to all-time highs, profit margins have – according to the BEA – dropped sharply from their peak (see first chart on page 2). The chief culprit is unit labour costs, which continued to trend higher in Q4. The question of why the productivity data may be wrong has been examined in close detail before in this commentary, and in the book published last July (see AI: American Innovation and the Economic Recovery, GFC Economics, 2016).
In summary, failure to account for improvements in quality or capacity, with correct hedonic adjustments, implies that the investment deflators are wrong by a large margin. The biggest source of this mismeasurement – semiconductor chips – may be getting worse. A forthcoming article from GFC Economics will examine the growth of specialised chips, which are driving huge increases in performance. Far from slowing, Moore’s Law may be accelerating. The ramifications will be felt far beyond the chip industry: a broad array of today’s more sophisticated investment goods depend on semiconductors for their performance. The deflators for these will be too high. The delivery of so many services through the internet implies that the deflators for many areas of consumption are wrong too.
Summary
- Payrolls may be firm again on Friday
- However, tech-related job losses suggest rate hikes could slow in 2018
- Strong cash flow positive for equities
