Profits Soar as U.S. Corporations Have Best Year Since 1950

(Bloomberg Businessweek) -- The numbers are in: 2021 was the most profitable year for American corporations since 1950.

Profits surged 35% last year, according to data published on Wednesday by the Commerce Department, driven by strong household demand, which was underwritten by government cash transfers during the pandemic. In all four quarters of the year, the overall profit margin stayed above 13%, a level reached in just one other three-month period during the past 70 years.

It was a solid year for workers, too—just not in comparison to shareholders. Employee compensation rose 11%, but the so-called labor share of national income—essentially, the portion that's paid out as wages and salaries—fell back to pre-pandemic levels. That tends to undermine the argument that soaring labor costs are what's driving the current surge in inflation, a case the Federal Reserve is starting to make as it accelerates interest-rate increases.

The aggregate profit margin of non-financial corporate businesses has come down a bit since peaking above 15% in the second quarter: it stood at 13.9% at the end of the year. The elevated numbers have triggered a debate about whether opportunistic price hikes by U.S. businesses are partly to blame for high inflation, an argument pushed strongly by the Biden administration last year, though less so more recently.

Judging by the stock market, investors see more good times ahead for profits in 2022. After a bit of a swoon at the start of the year, the S&P 500 index has climbed back to within 4% of the record set on Jan. 3.

That's partly down to the sunny outlook for business investment, and household demand that shows few signs of fading even though it's no longer being propped up by fiscal stimulus, says Robert King, director of research at the Jerome Levy Forecasting Center in Mount Kisco, N.Y. The latest Fed data suggest that Americans accumulated some $4.2 trillion in extra savings since the end of 2019.

The story for 2022 is “a shift from direct government support for profits to the private-sector profit sources,” King says. Workers stand to benefit, too, because “strong profits lead firms to hire more, and in the current instance where there is not an enormous labor supply, there are still prospects for very strong wage growth.”

Risks to that outlook include the Fed's pivot to aggressive rate hikes and Russia's invasion of Ukraine.

The Fed raised its benchmark interest rate in March for the first time since slashing it to almost zero two years ago, and it's signaling many more increases to come. Meanwhile, the war has led to a surge in the prices of commodities such as energy, food, and metals, which is likely to eat into both corporate profitability and household budgets and keep inflation elevated.

Throughout 2021, as inflation picked up, Fed Chair Jerome Powell insisted price pressures were largely “transitory,” driven by pandemic disruptions—such as the massive shift of consumer spending away from services and into goods—that would eventually come to an end as the health crisis subsided.

Now, the Fed's story is changing. Consumer prices were up 7.9% in February from the year before, while average hourly earnings for production and nonsupervisory employees—a group that comprises over 80% of the U.S. workforce—were up 6.6%. And Fed officials increasingly see an important link between the two phenomena.

After the announcement of the rate increase on March 16, Powell told reporters that “there is a misalignment of demand and supply, particularly in the labor market, and that is leading to wages moving up at ways that are not consistent with 2% inflation over time, and so we need to use our tools to guide inflation back down.”

But the surge in profits, eclipsing any increase in workers' pay, belies the notion that wage demands are what's pushing prices higher, according to George Pearkes, a global macro strategist at Bespoke Investment Group in Charlotte. He points to labor's share of income, which isn't rising.

“It's completely inconsistent with a wage-price spiral,” Pearkes says. “There is no other way to put it.”

Read next: China Bets on $1.5 Trillion of Tax Cuts in Quest for Growth