Keep a Close Eye on S&P 500 Net Profit Margins
I thought I would write a little piece looking for a fresh perspective: let’s inspect a long-term (25 year) view on three vital indicators of health in the U.S. economy.
Below, a tracking chart from Zacks Research System on 1) the Fed Funds Rate 2) the AAA Domestic Corporate Bond Seasoned Issue Rate, and 3) Real GDP Growth (1-year change).
Deep non-financial forces are slowing U.S. growth. Looking over 25 years, one can conclude a stimulus of lower and lower interest rates, whether policy or private, has been fighting an uphill battle against a secular erosion in U.S. GDP growth.
In 1988, the U.S. managed a +4.0% growth rate in real GDP.
Following a downturn, from 1991 to 2000, the U.S. economy climbed back up to +4.5% in real GDP growth, before turning down to just above 0%.
From 2001 to 2007, the economy could barely rebound to +4.0% growth. Then, growth drifted down to a +2.0% rate, before the 2008 downturn.
Following a massive downturn, from 2009 to the present, in this cycle, the U.S. economy could barely reach a +3.0% growth rate on rebound. Now, it is steady, chugging along at a +2.0% rate.
The U.S. economy has been slowing down for 25 years.
Now let’s turn to net profit margins on the S&P 500 over the last two cycles:
Net profit margins got up to 10.5% in 2000, rising along with real GDP growth rate to +4.5%. In the next cycle, net profit margins rose above 11.5%. However, it was piggybacking on a lower rebound in GDP growth.
In this cycle? We are barely back up to 10% in net profit margins.
One cannot help but conclude last cycle’s rise to 2007 on oversized S&P 500 profit margins toppled lower growth in real GDP. Oversized profit leveraging in a slower growing U.S. economy was part of the cause of a steep downturn. That is not a new insight. But it gets us up to the present.
In late 2012, we now have a struggle for more earnings and revenue growth on the S&P 500. And, in the last two cycles, a peak in net profit margins preceded the next downturn.
That leads us on to another insight on the present cycle and the present moment.
We need to see S&P 500 net profit margins either stabilize on a plateau before moving higher, or begin to face the music of a possible downturn. If net profit margins turn lower over an extended period of time, watch out.
I caution against panic, though. An ‘extended period’ of time may be best measured in terms of a year or more.
Watching S&P 500 net profit margins really matters! It is one leading indicator of a possible U.S. economic downturn.