Profit Margins
Superhuman Feats Got Us Here
The simultaneous “New Era” ascension in margins and P/E ratios hasn’t generated anything exceptional from a return perspective. To the contrary, annualized S&P 500 total returns over this 25-year period of margin magic and (mostly) escalating P/E ratios merely match “Old Era” returns.
What’s Embedded In The Consensus?
Market momentum now seems to outweigh simple math in the minds of most investors, and we are not entirely immune. Today our tactical funds are positioned with net equity exposure of 50%, the midpoint of the normal 30-70% range. That’s a higher allocation than if we considered only business cycle dynamics and equity valuations.
Small Cap Quality Check
December’s Of Special Interest provided a recap of our Asset Allocation team’s view of small cap equities, suggesting that small caps had underperformed and reached a valuation discount that made them an interesting contrarian value proposition. Several clients responded with follow-up questions, wondering if the discount valuation of small caps was offset by their typically weaker business models.
Are Earnings Set To “Gap” Higher?
We are troubled that the bullish optimism has spilled over into the 2020 estimates for S&P 500 earnings. Zero growth in 2020 is probably not a bad guess for NIPA figures, but S&P numbers don’t always follow suit.
It’s Not What They Borrowed, But How They Used It
Following the deflationary bust of 2007-2009, the last decade was expected to be one of deleveraging. Only U.S. consumers appeared to get that memo, however.
A Spectacularly Average Thirty Years
In the spirit of good holiday cheer, we made a partial concession to the True Believers with a December “Chart of the Week” in which we narrowed our stock market valuation analysis to the historically elevated levels of last 30 years.
Allocation Implications Of Full Employment
While the economy’s move above its full-employment level carries reliably negative implications for profit margins, the impact on equity returns has varied greatly from cycle to cycle.
An Economy This Healthy Is Hostile To Profits
It’s hard to grow profits when an economy’s resources are already fully employed, a fact we highlighted when the U.S. Output Gap turned positive several quarters ago. Therefore, the first quarter drop in NIPA corporate profits, reported yesterday, shouldn’t have come as a surprise.
Margins Prove Capitalism Still Works
Corporate profits were outstanding last year, but even the benefit of a 40% cut in the top income-tax rate wasn’t enough to lift the net profit margin back to the all-time high of 10.6% established in early 2012. Still, the latest 10.0% figure is more than a percentage point above the 2007 cycle high and about two points better than any other cycle high.
They Can’t Tax What’s Not Earned
With three quarters of a sharply lower corporate tax rate on the books, the median four-quarter trailing profit margin for both the S&P 500 and S&P MidCap 400 jumped to all-time records in the third quarter.
What Can Margins Do For An Encore?
A massive drop in corporate tax payments lifted the third quarter NIPA profit margin back to the 10% level for the first time four years. But while we try not to always view the glass as half empty, we find it troubling that margins remain well-below their 2012 highs (10.6%) in spite of this one-time windfall.
The Gap Is Back!
We celebrated the official closure of the GDP Output Gap in December, but that milestone was revised away in April by the statisticians at the CBO through a downward adjustment to the estimated rate of “full employment.”
Musings On Margins
Fourth quarter earnings were the last ones to be burdened by a 35% top marginal corporate income tax rate, and therefore seem to have been given a pass by the analyst community.
Multiple Contraction—Just A Little Patience?
Things were bigger when you were a kid. Like that enormous sweatshirt your aunt gave you for your birthday or that hand-me-down ten-speed bike with the cross bar taller than your shoulders.
The “Gap” Is Gone. Now What?
In Q3, the CBO’s Nominal Output Gap swung to positive for the first time since the last business cycle peak. This type of move has historically meant the cyclical peak in profit margins is close at hand.
Sector Margin Checkup
U.S. companies hoping for a reduction in the corporate tax rate are not exactly doing a convincing job of demonstrating “need.”
Recent Years’ Oil Price Experience Akin To 1980s’
We revisit commentary we published in 2015 regarding the late-2014 oil price crash and review why, at that time, we believed oil prices could stay at depressed levels for a longer period than most expected. Additionally, we advise avoiding two Energy sector segments: companies with high balance-sheet risk, and Energy Royalty Trusts.
How To (Almost) Double Your Money In Under Ten Years
Buying the S&P 500 on one of the worst possible days in history ultimately yielded a total return of +87.4% (+6.8% annualized) through the end of April 2017...darn, sounds like an advert for Vanguard!
Sector Profit Margins: A Long-Term Review
Despite real GDP growth of just 1.6% in 2016, the median S&P 500 company earned a net profit margin of 9.7%, only 40 basis points below the record high established in 2014.
“Trailing” EPS Revisited
The S&P 500 trailing P/E has just climbed above 25x—lower than in March 2009—but incredibly high for any period in which earnings weren’t tainted by recession.
Valuations: The Correction That Never Was
The correction failed to meaningfully “reset” any long-term valuation measures, hence, we don’t view the current environment as having much investment merit, but rather, primarily speculative appeal.
Profit Margins At The Sector Level
S&P 500 profit margins mask the disparate trends taking place on a sectoral level. We dissect those trends with the ten major sectors grouped by five broad themes: Cyclicals, Commodities, Defensives, Interest Sensitives, and Tech/Telecom.
Margins: Mean-Reversion Works
A late March issue of The Economist proclaimed “profits are too high” and “America needs a giant dose of competition.” Funny. NIPA Corporate Profits figures released that week show The Economist’s plea for lower profits had already been fulfilled—and not just in the latest quarter.
Implications Of Low Growth, Low Inflation, Low Rates
The current environment will likely persist longer than most expect which will put further downward pressure on profit margins. As margins come under pressure, companies increase leverage to prop up ROE. However, the market wants higher duration, not higher leverage.
To Play The Rally, Or Not To Play?
Question: What will you do if the Major Trend Index returns to its bullish zone?
Margins: Reversion Can Be Mean
In Q2, NIPA’s EBIT margin fell to a new four-year low, over one point below the early 2012 cycle peak.
Earnings: What Is Normal?
Corporate profits are notoriously cyclical, and for decades we’ve sought to temper their swings by using a five-year smoothing of S&P 500 EPS in our valuation work.
Margins Showing Some Cracks
While NIPA profit margins peaked nearly four years ago, median margins across the S&P 1500 (and particularly within the S&P 500) managed to hold up until just the past three quarters. But it now looks as though the long-awaited margin squeeze is finally underway.
Earnings: Less Than Meets The Eye
Amid all the praise heaped on the corporate sector for posting record earnings in the midst of a sluggish global expansion, allow us a respectful vote of dissent. Earnings are abysmal—especially among the S&P 500 companies presumed to be the torch-carriers for this cycle’s profitability rebound.
Profit Margins At The Sector Level
A look at profitability trends at the broad sector level; only Utilities and Telecom Services are experiencing levels below their long-term medians.
Margins: Two Interpretations
Government accounting on everything ranging from the CPI, to the budget deficit, to even the unemployment rate is constantly assailed as being too rosy. So when a government report occasionally paints a less optimistic picture than the consensus one, we’re inclined to sit up and take notice (especially when we agree with it).
Sector Margin Trends
The S&P 500 record median profit margin of 10.3% is now almost a full percentage point above the last cycle’s peak of 9.4% (second quarter of 2007). Trends across S&P sectors are not as uniform as one might expect, though, with only half of the ten sectors last quarter at profitability levels that exceeded their 2001-2007 expansion highs.
Just When You’d Stopped Worrying...
A good rule of thumb for fundamental forecasters is that projected events almost invariably take much longer than anticipated to occur, but then—once underway—unfold with much greater speed and power than originally expected (think subprime).
Running The Math On Mega Caps
The recent move by the S&P 100 Index (OEX) above its historic March 2000 high prompted us to take a closer look at the turnaround potential of this perennially underperforming Mega Cap index. Remember, a Large Cap leadership cycle has been in force since April 2011—with the trend strengthening the last few months. What are the prospects for the biggest of the Big Caps?
Profits: “Margin”-al Improvement In Q4
Q4’s margin figure is only one tick below the all-time high of 10.3% set in Q4 2011.
Corporate Profits In 2014
Earnings growth over the next few years will—in the best case—be forced down to the rate of top-line growth (nominal GDP).
Sector Margins: Just Thank The Consumer
We’ve noted before that profit margin gains since the technology boom have been primarily a Large Cap phenomenon.
Decomposing Today’s Record Profit Margins
The celebrated gains in corporate profitability over the past decade and a half are attributable primarily to proportional declines in “below the line” items like interest expense and corporate taxes.
Profit Margins: As Good As It Gets
Current record high corporate Profit Margins examined in this month’s “Of Special Interest.” Topics include the sustainability of the trend, commodities as profit trackers, margins as a potential forecasting tool and discussion on profits by sector and market cap.
Sector Level Profit Margins: Q2 Update
An examination of both near term and longer term historical profit margins broken out by sectors is presented in this month’s “Of Special Interest” section.