Monday, March 31, 2014

Is the Profit Margin Set to Revert to the Mean? (excerpt)

There’s a raging debate over the profit margin--not so much in Boston, where I visited our accounts last week, as between the WSJ and Barron’s. In his 3/27 WSJ column, Justin Lahart noted that Thursday’s GDP report showed that the profit margin rose to yet another record high of 11.1% during the fourth quarter. He notes that most of the factors that have contributed to this development could be reversed: “Keeping costs low by refraining from hiring or not replacing equipment can only be done for so long, though. And long-term interest rates look more likely to rise than fall over the next year. Losses to offset taxes, too, eventually get used up.”

In his 3/29 Barron’s column, Randy Forsyth reviews the contrary views on this subject held by Robert Buckland, Citigroup's head of global equity strategy. Randy summarizes Buckland’s main point as follows: “Of course, companies must invest to generate future returns, but overinvestment drags down profitability, growth, and employment.”

I’ve been arguing that margins are likely to remain high because I expect companies to continue to be cautious about expanding their capacity and payrolls. However, I am becoming concerned that deflationary forces (more competition and more technology) could depress margins from the top down.

Needless to say, the record high in the profit margin is bound to continue to inflame the income inequality crowd. During Q4-2013, wages and salaries in compensation accounted for just 48.9% of national income, the lowest share on record. Total compensation (including supplements) fell to 60.7% of national income, the lowest since Q4-1951. Of course, the data are pre-tax and before social benefits, which significantly reduce income inequality.

Today's Morning Briefing: Boston Views. (1) Cold, but calm, in Boston. (2) Mostly bullish, but seeking value. (3) The expansion is mature. (4) The capital-spending debate. (5) Why hasn’t ultra-easy monetary policy been inflationary? (6) Could it be deflationary? (7) Italian and Spanish bond yields anticipating ECB response to deflation risk. (8) Japanese bond yields show skepticism about Abenomics. (9) The profit margin debate. (10) What will it take to revive EMs? (11) Rational and Irrational Exuberance. (12) Putin’s melt-up or meltdown? (More for subscribers.)

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