Slowing Profits Bad News for US Stock Market

A number of factors seem poised to put pressure on corporate profits, likely creating a headwind for equity markets in the years to come, says Morningstar's Bob Johnson

Robert Johnson, CFA 15 August, 2016 | 10:56AM
Facebook Twitter LinkedIn


Bob Johnson: Corporate profits are a key driver of stock market activity. Over the past couple of decades, profits have grown considerably faster than GDP. This caused profits to take an increasing share of GDP, peaking at about 10% or so. That's well above the long-term average of about 6.5%.

So, what drove that increase? Well, certainly, very low labour costs helped during that period of time along with very low interest rates and pretty attractive productivity growth. You combine all of those and we had an increasing share going to corporate profits. However, over the last couple of years those profits have begun to decline again.

Why is that? Well, we've certainly had an unfavourable commodities experience with oil, in particular, going down, and oil is not an insignificant part of corporate profits. Certainly, labour costs have increased with increasing labour shortages as well, and productivity growth isn't what it used to be, all depressing corporate profits.

Unfortunately, the prognosis for profits going forward is not particularly good. Labour costs are just beginning to accelerate frankly and we also expect the commodities cycle to last a little bit longer, and probably interest rates will eventually move higher.

That's not great news for equity markets. During periods of rising profit, markets have performed much better than periods when profit growth is slowing. Since the 1950s markets have risen about 15% or so during periods of rising profits but only 9% when profit growth is slowing. Looking at this data, it would suggest that as profits slow in the years ahead that equity markets will face a headwind, but not necessarily a disaster.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

About Author

Robert Johnson, CFA  is director of economic analysis with Morningstar.

© Copyright 2024 Morningstar, Inc. All rights reserved.

Terms of Use        Privacy Policy        Modern Slavery Statement        Cookie Settings        Disclosures