The S&P 500 stock price index hasn’t been following the script of the bears during the current bull market.
Admittedly, there aren’t too many left, which is something for contrarians to worry about.
When the bears were more numerous and growling more loudly, one of their predictions was that the profit margin would “revert to the mean.”
It usually starts doing so during booms when corporations ramp up spending on labor and capacity expansion faster than revenues, which squeezes margins. Booms are inevitably followed by busts, which is when the profit margin reverts to the mean and falls below it, so that it can revert back up to the mean and surpass it during the inevitable recovery.
So far, this boom-bust narrative hasn’t played out as it did during previous business cycles. Joe and I believe that’s because corporate managements were traumatized by the Trauma of 2008, and have been very conservative ever since. In addition, most of them are facing intense pressures from disruptive technologies that pose existential threats to their business models. No wonder that they might be obsessed with maintaining as high a profit margin as possible. It has been different this time—so far.
Consider the following:
(1) The S&P 500 profit margin rose to 10.8% during Q2, the highest on record. Okay, the record only starts with Q1-1993 (Fig. 1). However, this measure is highly correlated with the ratio of after-tax book profits of all corporations in the US divided by nominal GDP, which are data included in the National Income & Product Accounts (NIPA). By this measure, the profit margin peaked at a record high of 10.8% during Q1-2012, and was down to 9.3% during Q2-2017.
Nevertheless, it remains well above almost all previous cyclical peaks. Besides, we put more weight on the S&P 500 profit margin because that’s a key variable in determining the profitability of the widely followed S&P 500 index.
(2) The NIPA profit margin that we just related to the S&P 500 profit margin has tended to peak during the booms at the tail ends of business cycles. Debbie and I have found that these peaks, which marked the beginning of the margin reverting to the mean, coincided with business costs rising rapidly relative to GDP (Fig. 2).
(3) Business costs are compensation of employees plus private nonresidential fixed investment spending as measured in the NIPA (Fig. 3 and Fig. 4). The sum of the two as a percentage of GDP fell to a cyclical low of 64.0% during Q1-2010, which was the lowest reading since Q1-1955. It was back up to 66.0% during Q2-2017, which remains below the previous four cyclical troughs!
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
© 2022 Newsmax Finance. All rights reserved.