Income inequality is usually a purely political topic, but EPS growth is extremely high by historical standards and some people are becoming worried that we could be in the middle of a profit bubble.
Profits are high by historical standards
“Profits are dangerously elevated by all reasonable measures,” writes Research Affiliates analyst Chris Brightman. “Industry profit margins are at or near all-time highs. Corporate profits, both as a percentage of GDP and relative to labor income, are at or near record levels. The dramatic rise in income inequality is a direct consequence of this spectacular reallocation of income to capital and away from labor.”
Brightman argues that, contrary to the experience of the current generation of finance professionals, it is possible for the economy to undergo decades of flat or negative real EPS growth as profits realign, which he says happened in the 1880s – 1890s, the Worlds Wars, the 1930s, and the 1970s – 1980s.
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Brightman’s not the first to worry about the impact that stagnant wages could have on the economy. While a rebounding housing market was enough to improve raise expectations, the earnings growth that many people expect for 2014 will need to be driven, at least in some part, by a middle class that feels increasingly financially insecure. It’s no coincidence that discretionary consumer spending is one of the weaker sectors of the economy right now.
Brightman: expect expenses to rise faster than sales
It’s easy to point to macroeconomic trends that may be behind these changes (competition with cheap foreign labor, the role of technology, and the overreach by unions are all likely candidates), but Brightman is much more concerned with what will happen next.
Brightman isn’t necessarily an advocate of economic regulation, but he seems to think that as capital’s share of profits grows, political change will become inevitable. “We cannot predict the quarter or year when profits will peak. We can predict the catalyst. The share of corporate profits is a political choice,” he writes. “Expect corporations’ labor, interest, and tax expenses to rise faster than sales over the next couple of decades and profits to grow much more slowly, or even decline, in real terms.”