The latest letter from GMO portfolio strategist James Montier tries to explain the source of ultra-high corporate profits in the midst of a mediocre recovery
The source of profits aside, the big lesson for investors is summarized in the title, which is: What Goes Up Must Come Down!
Indeed, Montier presents what on the surface appears to be one of the bears’ most compelling arguments, which is that no matter how much the economy is recovering, or how cheap stocks seem to be, margins are just ridiculously high now, and have to come down.
This is the money chart right here.
Click to enlarge…
Photo: GMO LLC
So not only are margins already historically high, but analyst projections anticipate them going even higher.
If you’re bullish on stocks, what’s your answer?
A few ideas we can think of:
- PE multiples will expand, ergo margin pressure isn’t a problem at these levels (This is an argument that Citi’s Tobias Levkovich has made).
- Stocks are still very cheap on an equity risk premium basis (i.e. compared to how expensive Treasuries are).
- Growth will surprise to the upside. In particular, rising wages and employment will improve the topline, cancelling out margin pressure.
- Margins are on a secular uptrend (there’s some evidence for this) and so historical levels don’t matter.