WHAT GOES UP MUST COME DOWN: Today’s Profit Margins Should Eventually Collapse…

Everyone who is bullish about the stock market needs to take a long hard look in the mirror and answer the following question:

Why is it different this time?

Specifically, why, this time, unlike any previous time in recorded history, will profit margins stay at today’s near-record highs?

In the past, every time profit margins have gotten this high–which has happened only twice since the 1950s–they have subsequently collapsed, taking profits down with them.

And when profit margins collapse, stock prices generally collapse.

So, again, the question everyone who is bullish needs to answer is “Why are profit margins going to remain at or above all-time highs for the foreseeable future?”

Profits As A per cent Of GDP
Corporate profits as a per cent of GDP.

[credit provider=”St. Louis Fed” url=”http://research.stlouisfed.org/fred2/graph/?id=CP”]

Leaving aside the stock market, what one hopes might happen over the next several years is that profit margins regress to more normal levels because companies voluntarily choose to hire more rank-and-file workers and pay them more.

This would help reduce the unemployment rate, and it would also begin to ease the extreme inequality that has developed in recent years and pump more money into middle-class pockets. And that, in turn, would help the broader economy, because middle-class spending is what really drives overall economic growth.

And it’s not as though companies don’t have the means with which to do this. As noted above, corporate profit margins are near all-time highs. And wages as a per cent of GDP, meanwhile, are at all-time lows (see chart below).

Wages as a per cent of GDP
Wages as a per cent of GDP.

[credit provider=”St. Louis Fed” url=”http://research.stlouisfed.org/fred2/graph/?id=WASCUR”]

Of course, stock-market investors aren’t supposed to care about things like that–about unemployment, living wages, general economic health, and that sort of thing. Stock market investors are supposed to care only about profits.

So, again, that leaves one simple question: Why, with respect to corporate profit margins, is it going to be different this time?

And if the answer is that it’s not different (it usually isn’t), the next question is not “if” but “when?”

SEE ALSO: The Stock Market’s About 30% Overvalued