U.S. companies are the most profitable that they have been in more than 40 years, and some of the best-known stock pickers are divided over how long that will last.
Bob Doll, chief equity strategist at
BlackRock Inc., said that low labor costs and cost-saving technology will allow companies to keep up their profitability. Jeremy Grantham, chief investment strategist of Grantham Mayo Van Otterloo & Co. LLC, said that margins will send stock markets tumbling when they eventually revert to their mean.
GMO, an investment manager that oversees $93 billion, puts the fair value of the S&P 500 at between 950 and 1,000, compared with the 1,192.55 level at which it closed last Monday.
U.S. companies' ability to squeeze more profit from each dollar of sales is pushing earnings higher, even as the economy has grown at a below-average clip since the
recession ended in June 2009.
Mr. Grantham, who called corporate profits “freakishly high” in an August commentary, sees wide margins as an aberration.
Some of his competitors said that changes in the economy and the way that firms operate could keep them near peak levels for another year or two.
“We don't think they have to fall,” said Mr. Doll, whose firm is the world's largest asset manager, with more than $3.35 trillion.
LABOR, TECHNOLOGY
The weak job market and investment in technology are likely to persist, Mr. Doll said.
“We lean towards the optimistic side,” he wrote in a Nov. 21 note on the stock market's prospects.
The margins of non-financial companies in the United States, a widely used measure of profitability, reached 15% in the third quarter, according to data from Moody's Analytics Inc. That was the highest level since 1969.
When the recession ended in the second quarter of 2009, the comparable number was 8.7%.
Moody's measures margins as total profits for non-financial companies divided by the contribution of those businesses to the gross domestic product. The number captures the results of a range of public and private companies, and isn't distorted by the big swings in earnings of financial firms, according to Mark Zandi, chief economist of Moody's.
Those on both sides of the debate agree on two things: Margins are unusually high, and the driving force behind their rise is companies' ability to keep a lid on expenses.
"MARVELOUS JOB'
“Businesses have done a marvelous job of reducing costs,” Mr. Zandi said.
Workforce globalization and a U.S. jobless rate of 9% last month have given management the upper hand in dealing with labor, he said.
Wages and salaries as a share of national income fell to 49.4% in the third quarter, the lowest since the government began collecting the numbers in 1948, Moody's data show.
Companies, while slow to hire, have been upgrading technology.
Businesses invested in equipment and software at an annual pace of $1.15 trillion in the third quarter, up 26% since the fourth quarter of 2009, data from IHS Global Insight show.
EMERGING MARKETS
Profit margins have been bolstered by sales to faster-growing economies in Asian and Latin American emerging markets, which have helped companies offset weakness in Europe and the United States.
American multinationals “are much less dependent on developed-market economies than they have been in the past,” William Stromberg, director of global equity research at
T. Rowe Price Group Inc., wrote in a November newsletter.
Dennis Bryan is skeptical that the trends that have supported margins can continue.
He is co-portfolio manager of the $1.2 billion FPA Capital Fund, the top-performing diversified U.S. stock fund over the past 25 years, according to Morningstar Inc. The fund gained 14% annually in the period ended Sept. 30, Morningstar data show.
Firms may be reaching their limit in wringing out costs, after two years of rising margins, Mr. Bryan said.
“Will companies be able to keep tightening their belts by cutting millions more Americans out of the workforce?” he said.
