Some economists say the US is heading for a recession.
Others don’t think we’re there just yet.
But Deutsche Bank’s Joe LaVorgna thinks there’s a sign suggesting that the pessimists might be on to something.
In a recent note to clients, he noted that the decline in corporate profit margins is a glaring indicator that, in a worst case scenario, a recession could be here within a few months.
“Historically, the average and median lead times between the peak in profit margins and the onset of recession have been eight and nine quarters, respectively,” wrote LaVorgna in a note to clients Thursday. “This would imply that the economy could enter recession in the second half of this year.”
“Margins always peak ahead of recession,” he added. “Indeed, there has not been one business cycle in the post-WWII era in which this has not been the case.”
Profit margins peaked during the third quarter of 2014, and have been steadily declining since, which LaVorgna suggests is a red flag.
He based his estimate of corporate profit margins on a per private worker basis, dividing total corporate profits from GDP by the total private employment.
Doing it in this manner shows the share of profits going to labour, when worker’s share increases substantially the business cycle is nearing its end.
“Normally, margins compress because of cost pressures — the labour share of income rises relative to the corporate share of income,” LaVorgna wrote.
“Put another way, when companies compete for scarce resources (labour), worker pay is bid up. In turn, inflation pressures often surface, and the Fed begins raising interest rates, sometimes aggressively.”
So as profits have declined and employment has remained on its steady upward trend, companies are paying workers more and margins have become compressed.
As of now margins are down 7% to $17,045 per worker, from $18,390 per worker, as of third quarter 2014.
However, there is one saving grace that may mean a recession is coming, but is not imminent.
“Of course, the lead time from the peak in margins to the beginning of recessions can vary substantially across business cycles — longer cycles tend to have longer lead times,” LaVorgna said. “For example, during the long 1960s and 1990s business cycles, the peak in margins occurred 16 and 15 quarters, respectively, before recession.”
But with manufacturing near or in recession, and some reliable indicators also sending warning signs, LaVorgna suggests we should be wary of a serious economic downturn.