Thursday, March 24, 2011

S&P Peak Earnings?

One of the main reasons the market has recovered so quickly from its lows during the recession is strong corporate earnings. Market bulls argue that earnings growth should continue to propel the market forward. But what is often not discussed is the means by which earnings have recovered: exceptional profit margin expansion. The following graph (part of a Special Report from Comstock describing why they are bearish on the market going forward) illustrates the profit margin for the S&P Industrial Average over the last several decades:

Consider how high profit margins were in 2010! Should we assume they can stay or even rise from these levels? Probably not. Profit margins have been mean-reverting in the past, and there doesn't appear to be a reason to believe they won't be in the future. Therefore, unless sales really take off, it seems improbable that earnings can grow at a reasonable clip in the coming couple of years; they may even fall.

(As an aside, consider how quickly profit margins rebounded in this recession as compared to previous recessions! Why?)


Alex said...

Is this shown ex-financials? Extraordinary government aid was a clear impetus to recovery of profit margins in that industry and may be juicing the speed profit recovery through that channel. Even ex-financials, government aid through extraordinary unemployment benefits and lowering of interest rates benefits all companies. I would argue that the lowering of interest rates happens normally, however, and the Fed QE action has not had any appreciable effect on interest rates (which are probably already at their lower bound).

Wade Garett said...

Is there any information on years prior to 1955?

Another interesting thing is the relative downtrend in margins and the uptrend in the S&P starting in the 1980s.

Perhaps you are on to something. Record low interest rates could help provide record high profit margins. But I'm not sure if that would explain the swings at the start of the decade.

Alex said...

Right - and I'm saying it's NOT the interest rates making this profit margin recovery extraordinary precisely because interest rates are usually cut dramatically in response to large economic downturns. Would think that it's rather something else, perhaps the unemployment support, the lifelines extended to the financial industry, etc. But probably government support in some form, it's the only thing that makes sense.

Natalie said...

How about record unemployment (labor cost is more than 2/3 of the cost structure)...

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