Profits over the past couple of decades have inflated to bubble-like record highs, and investors should expect them to decelerate or even decline over the next couple of decades.
That gloomy long-term forecast comes from Research Affiliates’ Chris Brightman in the Rob Arnott-led firm’s recent newsletter, but the profit warning comes with an unusual political twist:
Much of Brightman’s analysis emphasizes that today’s high level of corporate profits violates people’s sense of social fairness, accounts for rising populism and all but assures that “corporations’ labor, interest and tax expenses [will] rise faster than sales over the next couple of decades” while profits decline.
The profits bubble discussion comes at a time when the stock market hovers near its all-time high after a long bull run, leading many commentators to think a correction is overdue, while some bulls, like Wharton professor Jeremy Siegel, argue that corporate earnings fully justify today’s stock market valuations.
But what gives Siegel reason to celebrate is cause for deep concern on Brightman’s part. Profits, he warns, are “dangerously” elevated, with S&P 500 real earnings per share far above trend, profit margins at or near record levels and profits as a percentage of GDP and relative to labor income at or near all-time highs.
Capital’s share of income relative to wage earners seems socially unsustainable, he says, predicting that “social and political forces, if not economic developments, will cause it — sooner or later — to revert to a more usual level.”
Brightman, head of investment management for the Newport Beach, Calif.-based indexing firm Research Affilliates, warns that investment professionals should beware the human tendency to uncritically assume that the future will accord with the conditions they have known in their careers.
While “a multi-decade period of zero or negative growth in real earnings per share” needed to reduce corporate profits’ share of GDP may seem preposterous to many, history is replete with examples of sustained profit weakness, he says—the 1970s and 1980s being the most recent.
Brightman points out that the most recent profit bubble to end badly, in 2007, may now be exceeded by 2013 in real earnings per share (EPS) terms, and our current profits boom may now be the second highest in history.
The record holder, in 1916, was followed by a 39-year lull till the next profits peak in 1955, and Brightman points out that two world wars and a Great Depression came in the intervening years.