Recent economic data has been supportive of the advance in equities since the beginning of July, however, many of the important fundamental trends that are usually supportive of a prolonged late-cycle rally are absent, which suggests that the rally is built on shaky foundations — that’s according to a report from Barclays on the state of the US equity markets.

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Barclays US Equity Strategy analyst Jonathan Glionna and team have looked at the data from the last three prolonged late-cycle S&P 500 rallies (1988-89, 1998-99, and 2006-07) and found that in each case there have been a consistent set of fundamental trends, which have supported the rallies and fueled higher stock prices.

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Specifically, each rally was supported by expanding net profit margins, accelerating dividend growth, and increasing leverage. This time around, many of these trends are missing. Profit margins are declining and have been for a year, dividend growth has decelerated to the lowest level of this business cycle and while leverage is increasing (debt-to-EBITDA ratios are at the highest point this century) the S&P 500’s debt to equity ratio remains low by historical standards.

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Late-stage rally running out of steam? 

The lack of dividend growth in the market is the one trend that Glionna and team find the most concerning. The Barclays US equity team is forecasting a 6% increase in dividends for the S&P 500 in 2016. This is the lowest growth rate since 2010. Consensus estimates call for just 4.5% dividend growth over the next year.

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The primary reason why dividend growth is slowing is the existing high total payout ratio of the S&P 500. Including dividends and share repurchases the total current payout ratio stands at 128%, the highest level on record (four decades) outside of the financial crisis.

Therefore, it’s clear that the dividend payout ratio has little room to move any higher.

“Can the S&P 500 continue to set new highs without the support of better dividend growth? It is possible, but the last three prolonged late-cycle rallies suggest it would be an abnormal occurrence.” — Barclays

Stagnating profit margins are another factor at play here. Higher oil prices could support S&P 500 profit margins increasing from 8.8% back to 9.6% according to Barclays but outside of the energy sector, there’s little room for profit margin growth. Barclays is forecasting 2% revenue growth for the S&P 500 in 2016. The biggest impact to profit margins is likely to labor costs. As Barclays explains:

“The portion of gross value added paid out in compensation expenses by non-financial corporations have declined from 66% to 60% over the last 15 years. This trend is unlikely to continue. Wage growth has picked up. The Bureau of Economic Research’s data show that compensation costs at nonfinancial corporations are increasing significantly faster than sales. Considering that labor is the largest aggregate expense, a continuation of this mismatch would surely lead to lower profit margins.” — Barclays

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If f profit margins begin to increase again, dividend growth re-accelerates and leverage continues to go up, perhaps the recent equity rally can continue, although this scenario is unlikely to unfold, as Barclays sums up:

“We do not believe the fundamental conditions are present to support a prolonged late-cycle rally in equities. Rather, we reiterate our core thesis that U.S. equities are in a period of low returns. We forecast a total return of 3% for the S&P 500 during the last five months of 2016, based on our unchanged year-end target of 2200.”