U.S. Stock Bubble Is In Profit, Not Value Metrics

Agenda-Setting Financial Insight.
March 6 2012 1:25 PM

U.S. Stock Bubble Is In Profit, Not Value Metrics

Globalization and interest rates are two factors contributing to the profit bubble for American companies.

Photo by Matt Cardy/Getty Images.

There’s a bubble in U.S. stocks - but it’s in profitability, not valuation metrics. The S&P 500 Index trades at 14 times historical earnings, so the valuation multiple isn’t excessive. But a measure of domestic U.S. profit margins stands 50 percent above its long-term average. Global profitability has soared even higher. This is unlikely to last long.

Globalization is one factor driving up profit for companies in the United States. According to a March 2011 paper by the Bureau of Economic Analysis, foreign earnings represented 40 percent to 45 percent of total profit between 2008 and 2009, against around 20 percent in the 1980s.

However, even narrowing the scope to just domestic activities, profitability is still startlingly strong. In the first nine months of 2011, the aggregate post-tax profit of all corporations totaled 7.2 percent of gross domestic income, a measure similar to GDP. That’s well above the cyclical peaks of 6.4 percent in 1997 and 2006 and the postwar record of 7.1 percent. In the BEA’s records, the ratio of domestic profit to GDI was only higher in 1929, at 8.8 percent. The current level is half as high again as the long-term average of 4.8 percent.

A chunk of the surge in profit derives from interest rates. Corporate leverage has increased in recent years, according to the Federal Reserve, and the debt of U.S. nonfarm businesses currently amounts to 60 percent of the value of their equity. However, interest rates have declined. Ten-year Treasury bonds yielded more than 10 percent in the 1980s but under 3 percent in 2011. Based on recent corporate leverage, this decline in the cost of debt would increase the typical company’s return on equity by more than four percentage points. Conversely, corporate profitability in the high interest rate 1980s was well below the long-term average.

A deceleration in profit growth, at least, may already be priced in. Standard & Poor’s calculates that analysts now anticipate less than 1 percent earnings growth for the first quarter of this year compared with a year earlier, down from their rosier expectation of more than 12 percent growth less than a year ago. But if interest rates start rising, perhaps along with wage costs, say, a sharp decline in profit could follow. Suppose the profitability of companies in the United States declines to the 80-plus year average and valuation multiples remain constant, and the S&P 500 would be at 900 rather than its current level of around 1,360. That’s food for thought for stock market bulls.

Read more at Reuters Breakingviews.

Martin Hutchinson covers emerging markets and economic policy, drawing on 25 years of experience as an international merchant banker. He ran derivatives platforms for two European banks.



More Than Scottish Pride

Scotland’s referendum isn’t about nationalism. It’s about a system that failed, and a new generation looking to take a chance on itself. 

IOS 8 Comes Out Today. Do Not Put It on Your iPhone 4S.

Why Greenland’s “Dark Snow” Should Worry You

Three Talented Actresses in Three Terrible New Shows

The Human Need to Find Connections in Everything

It’s the source of creativity and delusions. It can harm us more than it helps us.


Happy Constitution Day!

Too bad it’s almost certainly unconstitutional.

The Ungodly Horror of Having a Bug Crawl Into Your Ear and Scratch Away at Your Eardrum

My Father Was James Brown. I Watched Him Beat My Mother. Then I Married Someone Like Him.

  News & Politics
Sept. 17 2014 2:57 PM ISIS Helps Snuff Out Conservative Opposition to Government Funding Bill
Business Insider
Sept. 17 2014 1:36 PM Nate Silver Versus Princeton Professor: Who Has the Right Models?
Sept. 17 2014 1:59 PM Ask a Homo: Secret Ally Codes 
  Double X
The XX Factor
Sept. 17 2014 1:26 PM Hey CBS, Rihanna Is Exactly Who I Want to See on My TV Before NFL Games
  Slate Plus
Slate Fare
Sept. 17 2014 9:37 AM Is Slate Too Liberal?  A members-only open thread.
Brow Beat
Sept. 17 2014 1:01 PM A Rare, Very Unusual Interview With Michael Jackson, Animated
Future Tense
Sept. 17 2014 12:35 PM IOS 8 Comes Out Today. Do Not Put It on Your iPhone 4S.
  Health & Science
Bad Astronomy
Sept. 17 2014 11:18 AM A Bridge Across the Sky
Sports Nut
Sept. 15 2014 9:05 PM Giving Up on Goodell How the NFL lost the trust of its most loyal reporters.