Corporate US – health check

The team at Pyrford look beyond the economic headlines and assess whether current profit levels can be maintai…

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In April, the IMF released its World Economic Outlook update and, as now seems routine, reduced the bulk of its growth forecasts issued just four months ago. World output for 2019 was downgraded to 3.3% from 3.5%, the advanced economies from 2.0% to 1.8% and emerging market and developing economies from 4.5% to 4.4%. World trade volume growth, which was projected at 4.0%, received a substantial downgrade to 3.4%.

Meanwhile, the US economy blasted through with an annualised real GDP growth rate of 3.2% for the March quarter. This is the advance estimate, which will be followed by at least two revisions, and history suggests that not too much reliance should be placed on this initial guesstimate. Net exports and private inventory build both provided unusually large contributions to growth, while government expenditure was also strong. Let’s see what the next release brings.

Pre-tax corporate profits rose by 7.8% in 2018 (3.1% in 2017). Profit margins remained close to a record high, whilst the share of labour remained close to its all-time low. After-tax profits rose by 16.2% in 2018, much higher than the pre-tax increase, reflecting Trump’s corporate tax cuts.

The devil is in the detail. Much of the US corporate economy struggled in 2018, recording lower profits. Manufacturing, wholesale trade, retail trade and transportation and warehousing were all down. Meanwhile, incoming profits from offshore businesses contributed substantially to performance (net of payments to the rest of the world).

We have little doubt that growth expectations for the economy and corporate profits have attained levels that simply cannot be achieved over the long term.

Over the long haul, profits rise at much the same rate as GDP. If we pick our way through some ancient data releases, we find that, since 1950, nominal corporate profits and nominal GDP have both grown at an almost identical compound annualised rate: 6.5% and 6.4%, respectively. The slightly higher rate for profits reflects its currently higher-than-normal share of GDP. Profits have of course been far more volatile than GDP, rising and falling at more extreme levels. For example, between the end of 2006 and the end of 2008, pre-tax corporate profits fell by 37%, whereas nominal GDP actually rose by 3.7%. Profits then quickly moved ahead and caught up with the GDP growth rate.

The US share market is in an effervescent mood. We have little doubt that growth expectations for the economy and corporate profits have attained levels that simply cannot be achieved over the long term. It is inevitable that the US and rest of the advanced world will experience lower GDP growth in the future compared with the past 60-70 years, largely thanks to demographic factors.

It is also worth reflecting on the extraordinary level of share buybacks in the US in recent times. According to S&P Dow Jones Indices, S&P 500 buybacks totalled $806.4bn in 2018, up 55.3% year over year, and up 36.9% from the 2007 record of $589.1bn. By 2009, buybacks had collapsed to just $137.6 billion. If stock markets are truly prescient, buybacks should have been almost non-existent in 2007 but racing ahead in 2009. We guess that answers that question.

Risk Disclaimer

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

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