Have Profit Margins Peaked?

Both the S&P and the US Bureau of Economic Analysis reported that profit margins dipped during Q4-2014. The former was at 10.2%, while the latter was at 10.4%. But both remained near their record highs of the previous quarter. One of our accounts observed that data that I compile are showing a possible peak in the forward profit margins of the S&P 500/400/600. That’s not so clear for the S&P 500, where the margin peaked at a record high of 10.8% during the week of December 4, 2014. It did dip recently, but edged up over the past few weeks back to 10.6% in early April.

The dips are more noticeable and remain underway for the S&P MidCaps. For the S&P 400, the forward profit margin is down from last year’s peak of 6.7% during the week of June 19 to 6.2% currently. For the S&P 600, it is down from the 2013 peak of 6.1% during the week of October 3 to 5.5% currently.

The perceptive fellow who brought this to our attention wondered why margins seem to be coming down more for smaller than for larger firms. That’s a good question, assuming that the forward profit margins accurately reflect the situation. We think so. We calculate the data by dividing forward earnings by forward revenues.

The pace of employment has picked up over the past year. ADP data through March show that payrolls are up 2.9 million y/y, with large companies adding 546,000, medium-sized companies adding 1.0 million, and small companies adding 1.3 million. The additional payrolls may squeeze margins more for small firms than for large firms simply because add-to-staffs are more significant to the budgets of the former than the latter.

In any event, profit margins may be peaking across the board, though they aren’t likely to tumble until the next recession. If they have peaked, then profits growth will be determined mostly by revenues growth, which is likely to be below 5% this year and next year.

Today's Morning Briefing: On the Margin. (1) More stagnation than boom or bust. (2) Commodity prices stabilizing. (3) Six cylinders firing in Eurozone, but recovery remains lackluster. (4) Waiting for US consumers to spend gasoline windfall. (5) Japanese output remains disappointing. (6) Chinese exports and imports are shockingly weak. (7) Bad news for Brazil. (8) Signs of profit margin peak, especially for SMidCaps. (9) Hillary’s challenge: Six out of 10 say junk Obama policies. (10) Focus on underweight-rated S&P 500 Materials.