“Is capitalism dead?” asks Albert Edwards, which is as exciting a combination of words as you’ll read today. The current thing exercising SocGen’s global strategy “team” is the record-high profit margins in developed markets, particularly the US:
After working in finance for over 40 years I had felt there wasn’t much that could surprise me. Yet I find the unprecedented levels of corporate Greedflation in this economic cycle astonishing. The latest release of US whole economy profits data delivered another shock to my weakening confidence that the capitalist system is working as it should. . . .
Companies have used first the pandemic and then the war in Ukraine to ‘profiteer’. At a time when social cohesion is already fraying at the edges, I think the sight of companies generating super-normal profit margins in a crisis can only inflame social unrest. This is a big issue for policy makers that simply cannot be ignored any longer. But what to do?
We summarised the gist of Edwards’ argument last month, to which his latest adds some reflections in favour of price controls and windfall taxes. Disregarding the lessons of the 1970s, with their failed price and income policies, may be necessary because “something seems to have broken with capitalism,” he writes.
The starting point this time is Bureau of Economic Analysis data that showed US fourth-quarter non-financial profit margins still running very hot relative to cost pressures, which was in contrast to market data that had suggested a cooling:
As per the above, labour shortages and higher commodity prices usually squeeze margins as an economy heads towards recession. That’s what companies have been reporting, but it’s not what the BEA data are saying.
The adjustments BEA makes to get an underlying picture of corporate profitability are to remove the profit and loss effects of inventory management, and to put depreciation on an economic rather than an accounting basis. Edwards suggests also narrowing the view to domestic profit only, reasoning that local profit is what drives the local business investment cycle.
This measure — which BEA terms profits from current production — suggests US underlying profitability has been clinging to a record high:
“One key feature of the BEA whole economy profits data is that it LEADS the stockmarket data, partly because smaller unquoted companies have no pressure to massage their results higher,” Edwards writes — which got us thinking. Which companies are we talking about? Who’s still over-earning, who’s massaging, and where might price controls bite hardest?
Here’s a very simple screen of margins across more than 1,000 global large-caps (Excel format, Bloomberg data). We’ve taken the quick and dirty approach and used only reported net profit, where the previous periods are the year-ago figure rather than annualised. Anyone contesting the value of this methodology is invited to share their own.
The screen shows net margins recently returning to a long-run average of 13.5 per cent, having been suppressed during the 2017 tech nonsense then inflated through the late-stage pandemic.
But on a granular view it also shows 52 per cent of global companies are still earning above their 10-year average margin, with the average excess of 2.15 percentage points.
Trend outliers are the obvious ones. There are startups that have recently hit breakeven (Tesla, Uber, Palo Alto) and unprofitable startups that have been reducing cash burn (Snowflake, Workday). There are pandemic stories (Moderna, AirBNB, Hapag-Lloyd) and restructuring stories whose net profit comparison is probably not like-for-like (Prudential, GE, Emerson Electric). There are also lots of banks and energy companies, whose current margins are either hyper-cyclical or inexcusable depending on your politics.
Here’s a horrible scatter chart that shows the distribution…
… and another that tops and tails from +20 to -20 percentage points:
The above shows if nothing else that profiteering’s easy to talk about from the top down, but very difficult to pinpoint. Our (admittedly very crude, as price controls tend to be) methodology offers only weak evidence that companies across the board have been over-earning relative to historical norms. And the outliers it highlights would be writing letters to the editor if we were to accuse them of anything, because mitigating circumstances abound.
That’s why we’ve taken the coward’s approach and turned the data over to you. Slice it however you wish and report any interesting findings in the comment box. The future of capitalism may or may not depend on it.
Further reading:
— Greed: bad, actually (FTAV)
— Central bankers warn companies on fatter profit margins (FT)
Source: Economy - ft.com
