One of the big fundamental concerns about the stock market right now is the level of corporate profit margins, which are at a 60-year high.
Profit margins are highly volatile, so extremes to one side or the other are typically followed by a sharp reversion to the mean.
Thus, some investors are concerned that today's super-high margins will soon correct to more normal levels, taking earnings down with them. And if earnings drop, the theory goes, stocks will tank, too.
Liz Ann Sonders, the Chief Investment Strategist at Charles Schwab, has looked at this question in detail.
She found the following:
- U.S. corporate profit margins are indeed at nearly 60-year highs
- Part of the reason for this is that American companies are now getting a big percentage of their profits from international operations, so the profit-margin-to-US-GDP is less meaningful than it once was
- Domestic profit margins are also high as a percentage of GDP, but not as stretched as overall profit margins
- Most importantly, stocks can still do well even when earnings growth rates are falling and margins are peaking
This last observation is surprising, but Sonders offers some specific data to back it up.
Bottom line, Sonders is more optimistic than many investors that stocks can continue to perform well from this level, even in the face of further declines in the rate of profit growth. She does caution that further profit growth will be dependent on an improving economy. And it's certainly not a foregone conclusion that we'll see that, especially in light of the unresolved "fiscal cliff" that is expected to put the U.S. back in recession next year.
- Investment & Company Information
- Charles Schwab