Yardeni Research | Record Profits on Record Margins

💡US Real Gross Domestic Income (GDI) grew by 2.6% in Q4 2025, significantly outpacing real GDP growth, which was revised down to just 0.5% during the same period. This divergence highlights a stronger underlying economic activity measured by income generation compared to expenditure on goods and services, indicating resilience despite a reported slowdown in real GDP. The average of real GDP and real GDI increased by 1.5% in Q4.

💡The strength of US GDI during Q4 2025 was primarily driven by solid increases in both labor compensation and corporate profits, despite a significant slowdown in real GDP growth to 0.5%. This indicates that the government shutdown and adverse weather in December 2025 depressed economic activity as measured by GDP but did not equally affect income generation. Nominal compensation rose 4.7% q/q (saar), and pre-tax corporate profits soared 9.6% y/y to a record $4.4 trillion.

💡US nominal compensation rose 4.7% quarter-over-quarter (seasonally adjusted annual rate) in Q4 2025, while hourly compensation increased by 6.3%. This strong growth occurred despite weakness in employment during the last three months of 2025. Inflation-adjusted hourly compensation growth is highly correlated with productivity growth, supporting the "Roaring 2020s" base-case scenario of faster productivity boosting consumers' real purchasing power.

💡US undistributed corporate profits reached a record high in Q4 2025, alongside tax-reported depreciation, which collectively resulted in a record-high corporate cash flow of $4.1 trillion. This surge in cash flow supported a record capital spending of $4.4 trillion during the same quarter. The after-tax profit margin also returned to its Q2 2022 record high of 13.7%, underscoring robust corporate financial health.

💡Private-sector employment grew slowly in the US during late 2025 and early 2026 due to several factors, including the impacts of more restrictive migration policies, the widespread adoption of artificial intelligence, and the increasing number of retiring Baby Boomers. Despite this slowdown, profitable companies are expanding capital spending, which also reached a record $4.4 trillion during Q4 2025, suggesting potential for future employment improvement.

💡Baby Boomers' retirement and wealth drawdowns significantly impact US consumer spending and the saving rate. As Boomers exit the workforce, their labor income decreases, but they continue spending by drawing from their $89.6 trillion collective net worth. This activity, evident in retail sales and spending on healthcare, travel, recreation, and food services, sustains consumer spending while simultaneously depressing real disposable personal income (RDPI) and, arithmetically, lowering the saving rate. This trend is expected to intensify, potentially leading to a negative saving rate.

💡The US CPI and PCED inflation measures structurally differ in weighting, substitution, and scope. CPI assigns a 35% weight to shelter inflation, while PCED assigns 16%. Core services excluding shelter have a 25% weight in CPI but 52% in PCED. PCED updates its weights monthly, allowing for consumer substitution, whereas CPI updates annually. CPI covers out-of-pocket spending by urban households, while PCED includes rural households and spending made on consumers' behalf, such as medical outlays covered by insurance.

💡PCED inflation has recently run higher than CPI inflation, an unusual phenomenon historically, primarily due to shelter inflation and supercore services. The October 2025 government shutdown distorted CPI shelter data by carrying forward earlier months' figures, effectively zeroing out measured inflation, which pulled CPI down more than PCED given CPI's 35% shelter weight. Additionally, "supercore" inflation, representing core services excluding housing, has remained sticky and carries a 52% weight in PCED but only about 25% in CPI, impacting PCED more significantly.

💡The October 2025 government shutdown significantly affected US CPI shelter inflation because the Bureau of Labor Statistics was unable to collect new price data. As a result, key shelter components, including rent and owners’ equivalent rent, were carried forward from previous months, effectively reporting zero measured shelter inflation for October in the CPI. This distortion contributed to a sharp moderation of CPI shelter inflation, pulling overall CPI inflation down more than PCED inflation due to shelter's larger weight (35%) in the CPI basket.

💡Cooling rental market inflation impacts US CPI more significantly than PCED because shelter inflation, encompassing rent and owners’ equivalent rent, carries a much higher weight in the CPI basket (35%) compared to the PCED (16%). As rental markets normalize and disinflationary trends take hold, the larger weighting in the CPI means that any moderation in rent prices exerts a greater downward pull on the overall CPI rate compared to the PCED, which is less exposed to these changes.