Nobody wants to be that guy – the one who is always drawing comparisons to ominous historical precedents. Right now, though, it is hard to overlook the disturbing fact that U.S. corporate profits, as a percentage of the overall economy, have surged to levels not seen since 1929.
If you’re looking for a simple explanation for why Wall Street has done so well over the past couple of decades, this monumental run-up in profits is it. Profits, strictly calculated, accounted for about 5 per cent of the U.S. economy a generation ago. They now make up more than 9 per cent.
If stock market analysts are correct, corporate earnings are set to rocket even higher over the coming year. No wonder stock prices are hovering near all-time highs!
But is this profit bonanza actually good news? This is where things get complicated.
Yes, profits are a wonderful thing. They drive companies to innovate and expand. They also provide the foundation for a rising stock market.
But unusually high levels of profitability often precede a crisis. That was the case in 1929, on the eve of the Great Depression. It was also the case in the mid-1960s, just before inflation took off and stock prices went into a two-decade funk. The profit share of the U.S. economy roared again in the 1990s, before the dot-com crash, and it jumped again around 2006, just before the financial crisis.
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This tendency for corporate earnings to peak immediately before a downturn is no accident. Profit margins expand when the government is spending lavishly, when interest rates are low and when companies are throwing money willy-nilly into new ventures.
The problem is that these growth factors are unsustainable. They tend to snap back with a vengeance. So profits often look their best just before the bottom falls out.
To be fair, the current profit boom may be more sustainable than most. Some stock market bulls argue that today’s robust bottom lines reflect a fundamental shift in how a modern, tech-oriented economy operates.
The most important shift is a significant decline in competition. In the old days, profits used to be dragged down by fierce rivalry. Whenever a company or a sector started to gush earnings, it would attract competitors and those new rivals would drive down prices and profit margins.
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But this self-correcting system doesn’t appear to work the same way in an economy dominated by quasi-monopolies such as Alphabet Inc.’s Google and Meta Platforms Inc.’s Facebook or Nvidia Corp.’s computer chips. These giant tech platforms enjoy an unusual amount of market power. They can’t be easily undercut by upstarts. Perhaps, then, they will be able to shield their profits in a way that earlier industries couldn’t.
Still, you have to wonder. At one time, companies such as the original General Motors, AT&T and Standard Oil also seemed to be impregnable monopolies. Yet even these historical titans eventually saw their advantages erode. Changing technology played a role in humbling them. So did politics. Workers and legislators tend to get upset when too much money flows to profits and shareholders instead of to wages.
For now, though, Wall Street analysts are brushing off any risks. Forecasts call for a 33-per-cent increase in S&P 500 profits this year and a further 16-per-cent advance in 2027, according to market researcher FactSet.
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These happy assumptions strike some observers as questionable. “If [the profit share of the economy] were to rise further, this would probably require the U.S. economy to keep growing strongly and competition among firms to be weak,” John Higgins, chief economic adviser at Capital Economics, recently wrote. “It’s also doubtful that workers would be willing to accept an ever smaller share of the pie.”
Even if workers remain passive, investors have to wonder how long profits can continue to grow when most of the big wins are confined to a narrow segment of the market.
Torsten Slok, chief economist at Apollo Global Management, points out that the recent boom in profitability is closely tied to the spending frenzy around artificial intelligence. Profit margins are rising for the Magnificent Seven tech giants – Alphabet, Amazon.com Inc., Apple Inc., Meta Platforms, Microsoft Corp., Nvidia and Tesla Inc. However, margins are flat for the other 493 companies in the S&P 500.
Profit margins are surging – for the Magnificent Seven tech giants. For the other 493 companies in the S&P 500? Not so much.
the globe and mail, Source: Apollo Global
Profit margins are surging – for the Magnificent Seven tech giants. For the other 493 companies in the S&P 500? Not so much.
the globe and mail, Source: Apollo Global
Profit margins are surging – for the Magnificent Seven tech giants. For the other 493 companies in the S&P 500? Not so much.
the globe and mail, Source: Apollo Global
The ability of the AI boom to keep powering profits ultimately depends on the ability of AI to generate real gains in productivity for the broad economy. Rather disturbingly, there are no signs this is actually happening.
“Despite massive investments and widespread hype around artificial intelligence, the technology has delivered zero financial payoff to corporate America outside of tech,” Mr. Slok concludes.
Investors may want to ponder this. Taken as a whole, the current earnings season is going well and profits are setting records. Under the surface, though, tensions are growing. Google’s parent, Alphabet, shed more than half a trillion dollars in market value this week after missing sales estimates. Worries are growing over how much it is spending to pursue the AI dream. Its problems could be an early sign that the great profit run-up of recent years is about to turn.
