Historically high corporate profit margins have spurred many observers to call for mean reversion.
An article by Baijnath Ramraika and Prashant Trivedi shows that long-term expansion in profit margins has been driven by lower taxes and lower SG&A.
Today's news by Wal-Mart suggests that the benefits of cost-cutting may be coming to an end.
There is a long running debate about whether current levels of corporate margins are sustainable. According to data from the Federal Reserve Bank of St. Louis current profits are about 10% of GDP, and have remained near this level since 2012.
Deconstructing Corporate Margins
Last year Baijnath Ramraika, CFA and Prashant Trivedi, CFA published research on the topic that became one of the most viewed articles on Advisor Perspectives in 2015: Why Jeremy Grantham Is Right about Corporate Profit Margins. I recommend this chart-laden article because of its embedded links, and its emphasis on a bottom-up analysis of corporate margins since 1992: Analysis of sectors, gross margins, SG&A, etc. This is economic analysis from the trenches, and not the ivory tower.
Charts 14 and 16 show that the long-term improvement in corporate profit margins mainly reflects lower taxes and lower SG&A. Corporations have cut costs to the bone, but anecdotal evidence suggests that the benefits of cost-cutting may be coming to an end.
Wal-Mart (NYSE:WMT) shares have fallen about 9% in mid-day trading today. The company announced that 2016 profits will decline, partly due to rising wages and ongoing investments in e-commerce. It sounds like the cost-cutting has gone as far as it can go, and Wal-Mart has to invest in both labor and technology just to remain competitive.
On a related note, the wage boost for long haul truckers also shows that the marginal dollar of shareholder returns is shifting from capital to labor.
As one would expect, Zero Hedge was quick to rain on the parade, dutifully pointing out that production workers may not fare as well as supervisory workers. Fair enough, but you've got to start somewhere.
I'll also be the first to admit that aggregate data on the economy and the S&P 500 often hides lots of granularity.
In my research of inflation signals this June, the most important warning sign for long-term inflation was increases in the Employment Cost. Greg Ip of the Wall Street Journal documented this back in April, so I'm hardly the first to point it out.
Recent developments at Wal-Mart bode ill for inflation and for corporate margins. Likewise for recent hikes in minimum wages and low-wage industries across the country. I am eager to see if this is just anecdotal, or if these anecdotal events are confirmed in the next quarterly release of the Employment Cost Index.
Perhaps this economic cycle has seen a peak in corporate margins. Corporations have been squeezing workers for years, and maybe they have squeezed all of the juice out of the lemon.
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