Margins revisited
Before our spring break, we observed that corporate margins, as measured in the US national accounts, remain extraordinarily high. Higher, even, than the numbers followed most closely by Wall Street — S&P 500 operating margins — would suggest. This is important to any assessment of the economy because margins are a leading economic indicator. Companies fire people when margins tighten, contributing to recessions. Still-high margins suggest that recession may not be imminent.
It is possible to regard today’s persistently high margins as a pandemic effect; Albert Edwards of Société Générale takes this view. Certainly, margins have not been as high as they were in 2021 and early 2022 in a long time. But in the case of US public companies, at least, it looks like the pandemic profit boom might be the culmination of a longer-term trend, rather than a distinct event.
We reach this (very tentative!) conclusion on the basis of a data set sent to us by Chris Mowbray and his team at S&P Capital IQ. It aggregates the profit margins of all public US companies since 1990 (excluding public companies that have no revenue, which can’t be said to have margins; and banks and other financials, for which revenue margins are a bad way to measure profitability). The data set is good because of its breadth and because it avoids survivorship bias: it looks at every US company that existed in each historical quarter, not just the historical margins of companies that still exist.
Here is what margins look like over the last three decades:
One interesting thing here is that in the case of both gross and operating margins, there was a 2021 peak, but it was not very much higher than the highs reached in the preceding 10 years (this is not as true when you look at the S&P 500; very big companies had a sharper spike in margins than all companies in aggregate).
Zooming in on operating margins, it is pretty clear that something happened after the great financial crisis. Through different stages of the economic cycle, margins are higher since 2010:
The crucial question for public company investors is not whether margins will mean-revert from post-pandemic peaks. They very likely will, though the precise timing can only be guessed at. The big question is whether they will revert to pre- or post-GFC levels.
It is natural to conclude that the post-GFC margin spike is somehow explained by monetary policy, given that after 2010 policy rates were pinned down and the Fed balance sheet growing. It is not clear to me exactly how this would work, however (remember operating margins are calculated before interest expense). Furthermore, there are other explanations available. Are companies underinvesting, boosting profits (and management pay) at the cost of future growth? This is the view of the economist Andrew Smithers. Or perhaps industry has become less competitive, allowing companies to pad margins without giving up market share? Or perhaps companies have had the upper hand against workers in recent years? We are keen to hear readers’ thoughts.