The stock market had a fantastic 2013 and we are often asked our opinion on what comes next for the market. If our crystal ball was not so hazy we could give a definitive answer… That said, later this week we will be sending out commentary on what we believe is the biggest factor for the stock market this year. Be on the lookout.
For today we wanted to touch on an important topic facing the markets. Over the past five years one of the biggest drivers of the stock market has been the increase in corporate profit margins. A company’s profit margin tells us how much of every $1 in sales that a company earns as a profit after all expenses are paid. It is no secret that revenue growth has been fairly tepid since the 2008-2009 recession but profit margins have skyrocketed, in large part due to corporate cost-cutting.
As you can see from the chart, margins have tended to fluctuate between 5% and 7% going back to the 1950’s. Among economists there is an ongoing argument: whether profit margins will revert to the mean, potentially causing pain to the stock market, or if higher profit margins have become the new norm. A key point… no one is arguing profit margins can march higher, which means sales growth will be a very important factor to future stock market performance.
Cullen Roche, one of our favorite financial bloggers, says mean reversion will happen, but no one knows when. He also points out that in the past profit margins have tended to contract during recessions, something that thankfully is not a current threat in the U.S.