Pass the Dip

On Friday, the Bureau of Economic Analysis (BEA) released their first estimate of GDP growth for the second quarter ending in June.  Not only was it an anemic 1.3%, but the 1st quarter’s growth was lowered to .4%.  Revisions to quarters in 2009 and 2010 showed that the recession was deeper than earlier estimates.

This raises the sinister spectre – again – of a double dip recession.  Yet Warren Buffett has said that he would bet heavily against the country going into a double dip.  What is Buffett looking at?

It might be corporate profits.  As the charts below show, corporate profits usually dip or level before a recession starts.  The last double dip was in the early 80s when the decline in corporate profits signalled the coming recession.

However, corporate profits briefly rose for two quarters before the 2001 recession.  The key indicator here is that profits barely surpassed the profit peak in 1999.  These graphs are in current dollars – they are not adjusted for inflation which was averaging 3% at the time.  This repeats a pattern prior to the double dip recession of 1981 – profits may rise for a quarter or two after a year or more of decline but they are relatively lackluster.

Prior to the recession that began in late 2007, corporate profits declined and leveled.

Let’s look closer at the past year, particularly the downturn in profits in the middle of 2010.  This was surely what Federal Reserve Chairman Ben Bernanke was looking at when the Fed instituted QE2 last September – an ominous prelude to a double dip.

Although this graph doesn’t show it, corporate profits have been rising – year over year – in the 1st quarter and apparently that is also the case for the 2nd quarter, as almost half of the S&P500 have reported in the past two weeks.

That year over year rise may be why Bernanke is reluctant to inject more money into the system.  Higher gasoline and commodity prices have taken a toll on corporate profits; the Japanese tsunami – 3/11 they call it in Japan – caused major disruptions in the supply chain; a high unemployment rate has led to a tepid consumer demand.  All this and yet companies have managed to increase profits.  This may be what prompts Buffett’s conviction that we will not slip into another recession – rising profits despite substantial headwinds.

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