Key factor driving corporate profit margins

by SoberLook

Corporate margins in the US are no longer expanding at the rate they were in the first couple of years after the recession. In fact margins are now undergoing a gradual decline.

WSJ: - Revenue at the companies that make up the Standard & Poor's 500-stock index—excluding banks, whose profits have soared—is expected to creep up by just 1.1% in the second quarter from a year earlier, according to Thomson Reuters, which melds Wall Street analysts' projections with company reports.
Earnings, meanwhile, are expected to decline 0.6%. That would be the first profit decline for nonfinancial companies since last autumn and the first time in a year that earnings grew more slowly than revenue, a sign that margin widening is petering out.

Analysts are blaming this on weak economic growth and poor business spending. Some are pointing to the end of the refinancing binge that allowed corporate treasurers to capture falling interest rates. That game is now over and lower funding costs will no longer add to margins. If we step outside the US however, most nations - particularly emerging markets - are seeing even sharper downward adjustments to margin growth.

Source: JPMorgan

According to JPMorgan, profit margins are heavily impacted by changing trends in labor productivity gains, which have declined globally. Change in profit margins is in fact proportional to the deviations from longer term growth trend in productivity. And emerging markets have seen the highest correction to that trend, resulting in higher reduction in corporate margins.

Source: The Conference Board

The US actually exhibits a relatively stable productivity trend which had accelerated right after the recession but has since declined. That's why US margins grew sharply after the recession and have been in a gradual downward drift recently. Nations such as Hungary and Russia on the other hand saw an extreme adjustment in the productivity trend, resulting in collapsing profit margins.

Source: JPMorgan

As we begin to adjust to lower profit margins for US companies, we should keep in mind that the declines are sharper for most other nations. Going forward, while business spending and interest rates will certainly have an impact, it's the labor productivity gains that will ultimately drive adjustments in corporate margins.

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