Company profits finally returned to growth in 4Q

Company profits finally returned to growth in 4Q

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The 4Q business indicators told a somewhat mixed story today. The data showed a 2.2%q/q rise in company operating profits (JP. Morgan and consensus 3%), while inventories were stronger than we had expected, rising 0.2%q/q (J.P. Morgan -0.5%, consensus 0.5%). After a prolonged period of weakness – profits had fallen in each of the previous four quarters – company profits, which are a significant input to the income side of the National Accounts (due Wednesday) will bring a welcome positive contribution to quarterly growth. Similarly, the upside surprise in today’s inventories number means that this component will, unexpectedly, also add will to quarterly GDP growth. Taking into account the net export information in the current account data also released today (see separate report), our preliminary GDP forecast is that the economy expanded at a healthy clip in the December quarter, albeit below our initial forecast of 1.1%q/q growth. This will be a marked acceleration from the 0.2%q/q gain reported for Q3.

Company operating profits look to have finally reversed the weakness that has been in place since 4Q08. The improvement is stemming from buoyant demand, but also more positive conditions for profit margins. The 4Q retail volumes data for example, delivered several weeks ago, indicated that consumption likely was strong over the quarter, which would have been a positive for firms in the manufacturing, wholesale and retail industries. Indeed, the sales of goods and services measures in today’s release confirmed this story, with each of these sectors reporting positive sales growth, and profits in the wholesale and retail trade industries rose 29% and 6% respectively. Given that both the trading conditions and profitability indices in the NAB business survey showed significant improvements over the quarter, this outcome was to be expected. Further, wages data for 4Q last week were very subdued, with the labour cost index printing at 0.6%q/q from 0.8% in the previous period, which would have further supported margins in the fourth quarter. On the other hand, the financial and insurance services continue to suffer aftershocks from the financial crisis, with profits falling 70%q/q after a near 40% fall in the previous quarter.

Inventories rose mildly in 4Q, up 0.2%q/q, and will likely add 0.1%-pts to quarterly GDP. We had expected that positive demand conditions may have had firms caught short on supply, leading them to run down inventories. In the breakdown, there is some support for this view – wholesale inventories fell 0.9% and retail 0.7%. The positive read on today’s number was due to a jump in stocks of the mining and manufacturing sectors (up 3.1% and 1.5% respectively).

Today's data confirms the likelihood of a strong 4Q GDP print on Wednesday. The GDP release will be delivered too late to be a direct input to the RBA Board’s decision tomorrow, though officials will be confident of an improvement from last period. We continue to forecast no change to the cash rate at tomorrow’s Board meeting, however it is a very close call. Taking the February statement and Board minutes at face value, officials had insufficient information on the state of the consumer to risk a further tightening at the last meeting. In the few intervening weeks since, little further information has been gathered on this front. We therefore see a pause as the more likely outcome, though the risk is that officials realize the need to have the cash rate at 5% by year-end may not afford the flexibility to pause for two months in a row.

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ENDS

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