Newspaper article The Journal (Newcastle, England)

Corporate Profits: Must What Goes Up Really Come Down? SHARE WATCH

Newspaper article The Journal (Newcastle, England)

Corporate Profits: Must What Goes Up Really Come Down? SHARE WATCH

Article excerpt

Byline: Andrew Miller

THE profitability of US companies has been impressive given the sluggish nature of the economic recovery.

However, many have seen high margins as unsustainable and a likely cause of a stock market correction, or worse. We have been less concerned, and see improving top-line growth as supportive of margins and able to offset any rising costs, at least until the next downturn.

There has been plenty of commentary surrounding the elevated profit margins in the US. The assumption that margins are mean-reverting is behind many of the more bearish views on equity markets, which argue for a market sell-off once margins inevitably collapse.

Margins cannot rise forever and will, at some point, start to fall, but they won't do so simply because they are at a high level; there has to be an underlying force that impacts profitability. A sharp rise in costs, particularly labour, could impact margins given the material fall in the US unemployment rate.

Wage growth has remained muted thus far though, and there is still enough slack to prevent a sudden jump in wages.

Similarly, while the tailwind of lower interest rates is likely at an end, we do not expect rates to rise sharply enough to bring margins crashing down.

Importantly, rising wages and interest rates will likely only occur in an improving macroeconomic environment. And such a scenario should, on balance, be supportive of margins. A significant economic slowdown, or an outright recession, would be the most likely cause of a margin collapse, as revenues would struggle to cover fixed and variable costs, but we do not see signs of either at present. In fact, we expect US and global economic growth to accelerate from here.

Despite common belief, the remarkable performance of corporate profitability post-crisis is not solely down to cost cutting. It can't be. Firms have indeed exhibited strong cost base discipline, but the end of asset writedowns in the financial sector, improvements in productivity, and revenue growth have all had a part to play.

GDP is considerably higher than its pre-crisis peak in the US, as well as in Europe. …

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