There’s good news and bad news on margins.
The bad news is, all three key tailwinds which helped corporate America more than double profitability over the past 30 years are waning and could turn into headwinds. I discussed that at some length here.
The good news is, profitability has likely stabilized in the near-term after falling in five of the last six quarters.
You could easily argue that the margin compression witnessed from the peaks in Q2 2021 is actually healthy. Like so many other pandemic dynamics, the profitability bonanza was unsustainable and risked turning into a PR liability to the extent politicians were inclined to push the “profiteering” narrative on voters.
In that context, the figure on the left below is almost a best-case scenario. Margins rose sequentially in Q1 after receding to pre-pandemic levels, and although you can’t see it from the chart, Q1’s net profit margin (10.8%) is very high historically. It’s only “low” in the context of the Trump tax cut aftermath and then the pandemic-fueled surge. What you want is stabilization and inflection from the trough. And that looks like what’s happening currently.
“Q1 2023 results revealed both a sequential increase in quarterly S&P 500 profit margins and the largest positive margin surprise relative to consensus estimates since Q4 2021,” Goldman’s Ben Snider observed. “Margins declined, but less than expected by consensus, and surprised positively in each S&P 500 sector.”
The counterargument is easy enough to make: Top-line growth may slow further as pricing power wanes, while input costs, including and especially labor bills, will remain sticky thereby crimping margins anew.
And yet, there too Goldman sees an inflection. “Last year, the rate of price hikes slowed by more than wage growth, compressing margins [but] wage growth has decelerated alongside declining job openings, and commodity prices have also softened,” Snider remarked, adding that the bank’s inflation and wage growth forecasts “suggest the worst of the margin headwinds have passed.” That’s consistent with NABE survey results, which show the difference in the share of respondents reporting rising prices and the share reporting rising input costs has improved.
I suppose this goes without saying, but the “good”/”bad” characterization employed above is from a shareholders’ perspective. Whether the doubling of corporate profitability over three decades was “good” from a societal standpoint is another discussion entirely.
For what it’s worth, a net 60% of respondents said they expect profits to worsen over the next 12 months in the latest installment of BofA’s Global Fund Manager survey.
That series remains near the most pessimistic levels ever.
