Corporate Profit Margins Have Peaked - ZT

ByStander

By Doug Kass
   
* The slight rise in margins incorporated in most 2011 corporate profit forecasts is mistaken.

The specter of lower corporate margins in 2011-2012 is an ursine theme of mine that has been ignored by market participants (so was yesterday morning's poor weekly claims report!).

The strength in yesterday's Philly Fed reading was underscored by most talking heads. The index soared to the highest level since 2004.

Ignored was that orders over the last six months have been flat.

Ignored were additional signs of lower margins. Deeper in the data was more and growing evidence of a contraction in corporate profit margins, a mean-regressing economic series that are currently at the highest level in 57 years.

Again, most 2011 corporate profit forecasts incorporate a slight rise in margins. I think this is mistaken.

As reported and graphically portrayed on Zero Hedge, prices paid soared from 54 to 67 (and are up by 55 since the fall). But the prices-received component of the Philly Fed is not rising nearly as rapidly as the prices-paid, and the difference between the two indices is at the highest level since 1979.

Jim "El Capitan" Cramer is among the most vocal proponents of ignoring raw materials and higher input costs -- he writes/says that investors should buy companies that are leveraged to the industrial recovery.

So far, he has been dead right!

To be sure, with the absence of wage inflation, it is nearly impossible to envision a 1970s-style inflationary problem. But screwflation, a distant cousin to stagflation, is the new problem of the 2010s.

Maybe Jim will continue to be right, but, from my perch, we are approaching the point at which (as I was reminded in an email exchange with Miller Tabak's Dan Greenhaus yesterday) there are two possible outcomes -- both of which, to varying degrees, make some of the more optimistic macro (and corporate profit) assumptions vulnerable:

   1. businesses try to increase prices, can't, and see their margins cut; or
   2. businesses do raise prices, people buy less, and revenue gets hit.

Better job growth will help as will the tailwind of spending by the affluent (the top 20% of earners account for 45% of all discretionary purchases), but I continue to have a minority view on the jobs outlook based on my sense of structural unemployment and on the notion that there is little to replace residential real estate as a driver to growth and employment (nearly 40% of the increase in jobs in the last cycle was real-estate-related). As well, the three mega trends (globalization, advances in technology and short-term hiring as a permanent feature of our workplace) provide a challenge to meaningful improvement on the jobs picture.