The idea that the corporate profit train will have to crash, or at least slow down, in the not too distant future has been percolating for a while now.
The combination of company cost-cutting and policy-driven demand, both of which have been keeping margins and profits high, will soon come to an end. We’ve written about all this before and think it makes sense.
Nomura analysts have a somewhat different notion:
— Q2 EPS results in the US were exceptional, not only showing record margins, but also a sequential acceleration in profit growth – all this in the third year of profit recovery and in the light of higher commodity prices.
— If the Q3 outturn can match Q2, then the disconnect between disappointing economic data, and only modest adjustment to EPS forecasts is increasingly likely to be resolved by an improvement in economic figures – as per the mid-2000s cycles – rather than a collapse in EPS.
Here’s a graph showing that corporate profit margins as a percentage of GDP hit a record high in Q2:
This obviously appears to be unsustainable, especially with an economy now confronting a higher chance of a new recession.
Nomura’s analysts don’t doubt this, but they emphasise that previous margin squeezes — defined as the two years after a peak in profit share as a percentage of the economy — haven’t led to big falls in equity markets or GDP growth:
Their point is that it all depends on what’s primarily driving the compression, and if it is “a result of increased hiring, wage growth and capex, the benefits for the wider economy may outweigh the impact of tighter margins.”
Well, sure, but if the profit squeeze is instead mainly the result of the economy tanking again and nobody buying anything — and if fiscal policy remains as contractionary as it is now expected to be — then this might be more 1972 than 1984.
But having previously shown you the bearish reasons for why earnings are likely to fall (which we find more persuasive, to be honest), we thought we’d mention another perspective.