Profit margins under pressure

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The deceleration in economic growth – and the entry of the US into the late stage of its expansion – casts a shadow on corporate profit margins. This year we could see a US-led earnings recession – typically defined as two straight quarters of annual declines in earnings. Some of the decline is explained by the unfavourable base effects from last year’s US corporate tax cuts. Yet other macro factors also suggest that US profit margins are likely to contract over the course of 2019. Highlights:

• US profit margins don’t look as strong as commonly thought once secular uptrends and favourable tax treatments are taken into account. And even the secular rise in profit margins does not have an entirely favourable interpretation – a lack of competition and concentration of market power appear to play an important role.
• We focus on profit margins derived from US national economic accounts (NIPA) for a few reasons. First, they have led the margin trends of S&P 500 companies. Second, they capture the rising role of private enterprises. Lastly, the composition of the S&P 500 is not stable. We believe margins have likely peaked and expect a material contraction in 2019 – a typical late-cycle pattern.