Monday, January 20, 2014

Economy/Stock Markets: Will Profit Margins Kill The Rally?

(Drivebycuriosity) - Since spring 2009 U.S. stocks have been rising more than 160%. The rally has been driven by company profits which have been climbing with a similar rate. The ubiquitous priests of doom claim that the rally will soon come to an end because profits will have to fall. Those bears refer to the fact that the profit margins of the companies (earnings in percent of the revenues) have climbed to a historical unprecedented high of around 10%.

As you can see in the chart above profit margins have averaged about 6.5% over the last 65 years and every time they’ve gotten well above that 6.5% range they’ve come back to earth (if the image doesnt function you can find it here:   pragcap   Google also shows a lot similar charts google).

I don´t agree. I believe that there are at least 2 reasons that profit margins will stay high and could even go higher:

1. The recent rally in company margins reflects a new industrial revolution. Since the early 18th century automatization has been enabling companies to produce more goods & services with the same amount of employees. More and better machines are doing the work of people which translates into lower costs and higher profit margins. Since the early 18th century the technological process has been rising our wealth significantly while simultaneously reducing our working hours.

It seems that this process is accelerating again. Car producers and many other manufacturers are increasingly using robots and similar machines to reduce their costs. Companies are beginning to use 3D-printers to become more cost efficient and flexible.

This developments are boosted by the rapid advance of information technology, meaning combinations of computers, smartphones, Internet and other digital systems. Software - which is increasingly Internet connected and uses more and more the cloud (access to huge external data centers) - organizes the whole business: Creating new products, inducing machines to run more efficient, finding cheap suppliers, manage customer relations and so on.

2. The recent jump of the profit margins also reflects the rise of the emerging markets. China & Co. create additional markets. Therefore companies can produce more which translates into shrinking average production costs (economies of scale). Emerging markets also deliver cheap supplies (most computers, tablets & smartphones are manufactured there) which reduces the production costs further.

All these developments are working together and are aggravating each other.  The blog "Continuations" speaks about "lightly organized global networks" (continuations). The described processes seem to accelerate again and to provide a surge of productivity & efficiency which should to keep profit margins above 10% or even to drive them higher. This should translate into further strong gains on the stock markets.

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