November 3, 2023

Hi everyone. My name’s Taylor St. Germain with ITR Economics, and welcome to this episode of Trends Talk. Today, I wanted to provide an update on the margin squeeze. We talked about this months back, but I wanted to bring this conversation back up. And the reason is because there’s a lot of conversations that we’re having internally at ITR, but also with our clients about some challenges as it relates to eroding margins. And the reason this conversation is timely is because we have just seen the US corporate profits, specifically US domestic, non-financial industries corporate profits, the rate of change fall below zero. So I think that really highlights some of the challenges we’re seeing from a bottom line perspective when we look at this profit landscape here in the US.

And so there’s, again, I wanted to call out the overall metric, which I just mentioned. Looking at a 3/12 rate of change for corporate profits, we have now seen that rate of change cross below the zero line and go negative with the most recent data point that we have. That number is at -1.9%. So compared to the same three months one year ago, we’re down about 2% from a profit perspective. Now, first, let’s talk about what that means in terms of future implications. I wanted to call out one relationship here to begin with, and that’s the relationship that corporate profits has to CapEx here in the US. So the series I’m referencing as it relates to CapEx is one of our Trends Report series that we forecast on a regular basis, and that’s US non-defense capital goods new orders, excluding aircraft. Of course, we exclude aircraft from that dataset because of how volatile the aircraft data is, but it’s a great proxy for business to business activity or CapEx activity.

And so when we take the corporate profits’ 3/12 rate of change and we align it with the annual growth rate for CapEx, we find that profits has about a nine month or three quarter lead time in terms of the directional movement, future directional movement for CapEx activity. So with that profits rate of change pointing below zero, that’s pointing to troubling times ahead as it relates to CapEx as we move into 2024. And now again, for those of you that are following the Trends Report and following ITR Economics, you’re very well aware of contraction in CapEx in non-defense capital goods new orders that we have had forecasted for quite some time for 2024. But this is just another piece of evidence that supports that forecast. Businesses are feeling financial pressure, and as a result, they’re likely to pull back in some of the CapEx spending as we endure this mild recession in 2024.

So that’s just one of the implications of this declining rate of change for profits. There’s many of them, many correlations as you can expect to a profits trend. But that’s a really important one, and I wanted to highlight that because we’re hearing out there a lot, concerns around cancellations, delayed projects, again, pullback and overall CapEx, and that’s all supported by what we’re seeing from the lead time that we get by comparing a data series like profits to CapEx. Now, that’s an implication of declining profits, but let’s talk a little bit about what’s contributing to some of this bottom line pressure, some of this decline in profits, and there’s a fundamental difference between where material prices are today and where wages are today, and that’s creating some of this strain on profits. So let me call out a few metrics here to give you some perspective.

If you look at some of these material costs like aluminum prices, iron, and steel, those rates of change on an annual basis are down about 17.8% and 17.1% respectively. So what am I highlighting there? I’m highlighting that commodity prices are down, overall material costs are down today. So there’s probably a lot of customers and clients of yours out there that are saying, “Hey, we know your material costs are down and we’d like you to decrease prices. There’s people looking for price decreases as a result of those lower material costs.” However, the challenge with affording some of these price decreases is at the same time, material prices might be down, we still see that wages are up, and that’s really what’s squeezing some of these margins and contributing factors to that decline that we’re seeing in corporate profits. So let me give you some wage numbers for perspective.

If you look at trucker wages or manufacturing wages, those are up year over year on a 12/12 rate of change, 6.2% and 4.4% respectively. So it’s really challenging to decrease prices at a time where there’s still increasing inputs that we’re all dealing with like wages. And that’s this delicate balance that’s going on as we have conversations with our customers and clients out there throughout the economy is people are looking for price decreases because material costs are down, but at the same time, we’re still dealing with higher costs as it relates to inflation. So it’s very important that we have these conversations but have in mind that it’s important to protect our margins. And yes, we’ll all experience likely some margin pressure, but that just means we’ll have some challenging conversations with customers and clients as we move forward as it relates to pricing.

Wages up, material costs down, it’s a really challenging time of the economic business cycle as it relates to margins. So it’s really important that we have a strategy moving forward into 2024 because of this margin squeeze. I hope you found this information helpful. For more information on our commodity price forecast for our employment perspectives, you can always check out the ITR Trends Report. But thank you for joining me on this episode of Trends Talk. I’m Taylor St. Germain, and I’ll see you on the next one.