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Warren, I’d be interested in your take on this – we hear from a lot of people how profit margins have proven to be very prone to mean reversion in time and that a decline here will result in a large fall in EPS.
Assuming so, one wold assume a catalyst is required – can margins just “happen”? A lot has been said of late about the US deficit being responsible for high corporate profitability and thus the pending decline in the deficit next year poses a risk. Your thoughts??
The only problem with this is that accountants have teamed up with executives to render corporate financial statements – particularly the balance sheet – completely and utterly meaningless.
Huge parts of “earnings” are from the financial sector, where “earnings” are what accountants pronounce them to be, not the cash that they might actually generate some day – or not. And as we have seen in the recent past, the probability of “or not” is quite high, particularly when there are almost no consequences of previous years’ “earnings” proving to be smoke and mirrors.
This is from a paper by James Montier at GMO. He is a smart guy and actually begins the paper by referencing Marx, Keynes and Kalecki as heterodox economic thinkers vs. rational expectations theorists. I was totally on board with his analysis until he concluded that the budget deficit in the US is unsustainable at current levels and will begin to be lowered over the coming years with a “deficit reduction plan”. Like Warren said, high profit margins are the result of moderate sales growth exceeding growth in input costs (wages) over the last decade or so. I would love to hear someone explain how this reverses w/o business investment, specifically in real estate, heading back to trend which would drive unemployment down and (maybe) apply pressure to profit margins in the form of higher wages. But if that happens, wouldn’t sales growth be stronger as well? My guess is that the trend for profit margins continues higher in the near term for non-financial corporations in the US, but I would love to hear a counter argument as to why that might not be the case.