Variant Perception says equity prices are rising and being driven by momentum, but profit margins are set to fall further in line with late-cycle wage pressures and tightness in the labour market.

Please consider  US Profit Margins to Fall Further.

The biggest cost to businesses is the cost of employees, and the unemployment rate leads the ups and downs of corporate profits as a percentage of GDP by about two years. There is still a long way to fall for corporate profit margins. This relationship holds going back over fifty years, although we only present the chart since the early 1980s for sake of clarity.

Variant Perception has built a leading indicator for wages, which leads the ups and downs of average hourly earnings by about a year and a half. VP’s leading wage indicator also leads corporate profits as a percentage of GDP by about 21 months. Lower earnings and lower returns on equity are baked in the cake.

Unemployment Rate vs. Corporate Profits

Varaint Perception corporate profitsA

Profit Margins vs. Wages

Varaint Perception corporate profitsB

The charts in the link are small unless you open them up. I did so on the first and immediately thought “what about wages?”

So I went into Fred and found a chart of wages, overlaid it on the first chart and noted the match was close but not quite right. Also it was difficult to match the scales precisely.

After playing around with the idea for a while, I returned to do this post and expanded the second chart.

The answer was right there in the text, but I missed it. In addition to problems of matching scale between Fred and Variant Perception, the first chart was offset by 2 years, the second 21 months.

Additional factors are in play. Here’s a list to ponder

Falling Corporate Profit Factors

  • Rising minimum wages
  • Retirement
  • Corporate profit mean reversion
  • Slowing global economy adds downward price pressures
  • Increase in subprime lending will increase writeoffs
  • Housing unaffordability will eventually stall the sector

There are many reasons to expect corporate profits to decline. Variant Perception has nice charts explaining one set of reasons.

Mike “Mish” Shedlock