US Profit Margins to Fall Further

Equity prices are rising and being driven by momentum, but profit margins are set to fall further in line with late-cycle wage pressures and tightness in the labour market.  The biggest cost to businesses is the cost of employees, and the unemployment rate leads the ups and downs of corporate profits as a percentage of GDP by about two years.  There is still a long way to fall for corporate profit margins.  This relationship holds going back over fifty years, although we only present the chart since the early 1980s for sake of clarity.

Variant Perception has built a leading indicator for wages, which leads the ups and downs of average hourly earnings by about a year and a half.  VP’s leading wage indicator also leads corporate profits as a percentage of GDP by about 21 months.  Lower earnings and lower returns on equity are baked in the cake.

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Source: Macrobond, Bloomberg and Variant Perception