Record high corporate profit margins have allowed corporate America to maintain profit growth even as revenue growth has stagnated.
Some, like John Hussman, warn that these margins will inevitably have to revert to a mean.
However, there are many who believe these high profit margins are sustainable and could actually rise further.
In his latest note to clients, Citi’s Tobias Levkovich points to one structural aspect of profit margins that often goes overlooked by the bears.
From his note:
A peak in corporate margins has been forecast by several market observers for much of the past two years even as the components of those S&P 500 margins tell a somewhat different tale. Essentially, profitability corrections typically are tied to economic recessions as fixed overhead costs are under-absorbed in the economy (often because companies cannot reduce employment staff as quickly). But the real mistaken view comes from misunderstanding the overall margin environment when removing the Tech sector’s influence (see Figure 6). If one looks at margins ex-Tech, it is easy to recognise that margins were higher elsewhere for years before the 2008-09 downturn, and there is still upside to most other S&P sectors’ profit opportunity.
The bears tend to look at margins more from a top-down, big picture perspective. Of course, corporate America as a whole will not be able to squeeze out profits like this forever. However, the warnings of imminent doom are a bit overstated.