Corporate America has enjoyed an operating environment very supportive of profit growth for the past several years. In fact, earnings for the companies in the S&P 500 are up about 150% since the year the Great Recession ended (2009), which translate to an annualized growth rate 11%. But perhaps it’s more instructive to the evaluate the growth rate in earnings since the pre-recession peak so we can see how it stacks up to history. It turns out that during the eleven year period from 2007 to 2018, S&P 500 earnings grew at an annualized rate of about 5.5% – very close to the average over the past 100 years or so. Think about that. The rebound in corporate earnings over just a nine-year period has been so powerful that it’s almost like the largest economic downturn since the Great Depression never happened. For all the talk of the anemic pace of this economic recovery, the pace of recovery in corporate earnings has been nothing short of miraculous!
Of course, the growth in corporate earnings since 2009 has not come from top-line gains so much as margin expansion. In other words, the majority of profit growth can be attributed to companies squeezing more profit out of each dollar of sales rather than actual increases in sales. There were a confluence of factors that drove margin expansion during the recovery. And just when it looked like margins were set to peak, Corporate America was given a gift that keeps on giving: a cut in the corporate tax rate along with other pro-business tax relief initiatives. But here’s the problem. Even as lower taxes will continue to support after-tax margins, pre-tax (or operating) margins may finally start to come under pressure as several favorable trends are beginning to reverse.
- Now that the unemployment rate has dropped below 4%, wages are beginning to rise at a faster rate. Continued labor shortages could accelerate the wage gains.
- While energy prices have pulled back in recent days, the price of oil is still up quite a bit in recent months
- Transportation/freight/shipping costs have been rising fairly rapidly due to a shortage of truck drivers (as well as higher fuel prices)
- Newly implemented tariffs have led to increases in input/commodity costs, like steel
- Debt services costs are rising due to continued Fed rate hikes and a surge in corporate debt (much of which was used to buy back stock)
- Economic growth has slowed fairly dramatically outside the US, with China posting its slowest growth rate (6.5%) since the Financial Crisis. Slower growth outside the US reduces demand for US multinationals’ exports
- The dollar has increased in value as the Fed continues to hike rates and US growth continues to outpace many other regions of the world; a stronger dollar makes US companies less competitive vis a vis their non-US competition
- Flush with the tax-cut windfall, many are speculating that some of these benefits might get “competed away” as companies lower prices in an effort to drive market share gains