The preliminary report on Q2 GDP does not confirm the US economy is in recession, but it does suggest that a corporate profit recession is underway.
Q2 Real GDP declined 0.9% annualized, following a 1.6% decline in Q1. Back=to-back quarterly declines in GDP are rare and usually occur when the economy is in recession. Yet, the drop in real GDP during the first half of 2022 is preliminary and not confirmed by the income side of the GDP accounts.
For example, Real Gross Domestic Income (GDI) expanded 1.8% in Q1, or 340 basis points faster than real GDP. That's a record gap. The long-run average is zero. In other words, Q1 had $677 billion more real GDI and $836 billion in nominal GDI than real and nominal GDP. That makes no sense. Q2 GDI data is unavailable, so it's unclear whether the income side confirms the second quarterly drop in real GDP.
Research has shown that the initial GDI reports are more accurate than GDP. Perhaps that is true because GDI has fewer data inputs. 80% of GDI comes from employee compensation and operating profits, whereas the GDP numbers include hundreds of series on sales, shipments, and inventories, many of which are revised a lot.
The Bureau of Economic Analysis plans to issue a report in September on the record gap between GDI and GDP.
The preliminary GDP report does not include an official figure on operating profits. But one can derive an estimate from the GDP data. Based on my calculation, Q2 operating profits will come in around $2,650 billion, off 6% from a year ago. That would be the second consecutive quarterly drop in operating profits, pushing the corporate earnings to their lowest level since Q1 2021.
Back-to-back declines in corporate profits are more common than back-to-back declines in GDP. In 2015, operating profits fell for four consecutive quarters, and the economy did not enter a recession.
Additional downward pressure on profits will probably come from further official rate hikes and slowing or declining economic growth. That might signal an economic recession down the road, but it would be wrong to conclude that the US is in recession today.
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