In a poll conducted earlier this week in the CFA Institute Financial NewsBrief, we asked readers where they thought U.S. corporate profit margins were headed over the next 12 months.
Since bottoming in 2009, corporate profits as a percentage of GDP have rebounded sharply and currently stand at about 11%, or approximately 70% above the long-term average. Warren Buffett once said, “You have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%.” And Jeremy Grantham has called profits margins “the most mean-reverting series in finance.” Both Buffett and Grantham noted that extraordinary profits attract competition, which ultimately cause profits to recede.
Oddly, profit margins today stand at all-time highs despite the weakest economic recovery in recent history. In “What Goes Up Must Come Down!” James Montier, Grantham’s colleague at GMO, offers an explanation along with superb analysis of the macro drivers of corporate profits. Montier demonstrates that record fiscal deficits are behind the surge in profit margins and, not surprisingly, expects fiscal retrenchment to cause them to shrink.
Amid the skepticism, there is no shortage of market pundits who think today’s exceptional profits are sustainable. Foremost among them may be Jeremy Siegel, who cites increasing globalization, which brings with it cheap labor and lower-taxed foreign profits, as well as the growing importance and weight of the highly profitable technology sector within the US stock market. Strong corporate balance sheets and low interest rates will also keep profits high, asserts Siegel.
Nearly two-thirds of the respondents to this week’s global poll seem to share Siegel’s optimism, with 43% expecting profit margins to stay roughly the same and 20% anticipating them to move even higher. Meanwhile, 38% of respondents expect profit margins to succumb to the laws of capitalism and begin contracting.
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