What sort of future is the stock market discounting right now? One in which there is a v-shaped recovery of corporate earnings…and in which profit margins go roaring right back to the 2007 all-time highs.
Bill Hester of the Hussman Funds lays it out. Here, per Bill, are the consensus projections for S&P 500 EPS for the next few years. We’re at the bottom of that “V” right now.
And here, per Bill’s analysis, are the profit margin assumptions underlying these happy projections. Analysts assume that we’re going right back to the extraordinary profit margins of 2007, which were a full three points higher than the average since 1950.
Is it possible that profit margins would return to those levels that fast?
No. Anything’s possible. But it doesn’t seem likely. More likely, analysts are being too optimistic, the way they have been consistently over the past several years, with the exception of a brief period early this spring.
What is worth highlighting is that analysts expect that the typical company will soon achieve the same level of profit margin that they were able to deliver in the years leading up to 2007 – a period where leverage was preferred over balance sheet strength, a preference by company managements to focus on equity shareholders, during a political climate where labour lacked bargaining power, where consumer spending was fuelled by mortgage equity withdrawals, and leverage ratios increased broadly because business and consumer credit was easy to come by. To assume a return to peak profit margins is a bet that the economic and political landscape that emerges over the next year or two will match the pre-panic landscape perfectly.
We’ll believe THAT when we see it.