Societe Generale’s Albert Edwards is one of many strategists who continue to warn that high corporate profit margins are unsustainable.
In his latest research note, he warns that the margin squeeze is on, and that’s likely to be bad news for the economy.
“[A] recession seems a distant prospect in the minds of most investors,” writes Edwards. “Yet one key precursor for a recession has now fallen into place. Slowing productivity growth means that unit labour costs are now running well ahead of output price inflation (see chart below). This means a margin and profits downturn is now about to unfold. That typically is a key precursor of recession.”
Predicting recessions is an unpopular practice on Wall Street. So you rarely hear about them until it’s too late.
“One thing that is axiomatic in this business: I have never ever seen the sell-side predict a recession,” he said. “There are a number of reasons for that, but key among them is the personal career risk of calling a recession and being wrong. Both the sell-side and the buy-side tend to do much better when the economy and the markets are doing well, so who wants to be a party-pooper. That is the nature of the beast.”
We are 55 months into the current economic cycle, which is a shorter duration than the previous three cycles.
But Edwards warns against think that that means this cycle can go on.
“Similarly, investors perceptions of the normal length of an economic cycle are strongly influenced by their own working experience,” he said. “In that context the last three economic cycles have been unusually lengthy, averaging 95 months from trough to peak (see chart below). But these cycles were perversions of the economic cycle, as the Fed manipulated the private sector credit cycle to extend the cycle which became known as The Great Moderation. The longer the cycle lasts, the more investors convince themselves that it has been abolished and lower their guard in relation to overpaying for cyclical investments (aka risk).”
According to NBER data, the average cycle has lasted around 36 months.
Edwards also notes that business investment has been slowing, which is an ominous indicator for the economy. The margin squeeze mentioned above only puts more pressure on businesses to reign in investment spending.
All of this looks very bad.
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