I jumped into a taxi on Tuesday evening last week. I must have looked mildly harassed, because the driver asked what I had been doing. I told him I had got back from an event in London an hour earlier, rushed home for a snippet of family time and was on my way out again for a work-related dinner.
He shook his head in sad pity. “It’s only the bosses that aren’t living like this,” he said with typical cabby wisdom. “It’s a boss’s life, pal.”
His point was a good one. Anyone who has been following the inequality debate that has taken off over the past year or so will have seen the charts that show just how much of a boss’s world it is.
Peter Bennett of Walker Crips makes the point well. His “killer chart” shows the share of US “corporate value added” that has gone to profits and to workers since the 1970s. It fluctuates around the same kind of level until the early noughties, when suddenly the share going to profits soars and that going to workers collapses.
This fits nicely with numbers you will have seen showing consistent falls in real wages alongside consistent rises in US corporate profit margins – which are still knocking around record highs.
Some think this is an entirely sustainable situation. There is, they say, no need for things to revert to the mean. Companies get better at doing things all the time, so it makes sense that they should keep making more money. At the same time, labour has lost its power.
The unions are a busted flush. Events such as the latest London Tube strike are the last gasp of a group that just doesn’t get it. Globalisation is likely to keep pushing wages down forever.
I have my doubts about all this. An awful lot of the things that have worked to boost profits in the last two decades are one-offs. As Bennett puts it, it isn’t just about companies getting better at what they do. Instead, “the corporate sector has been the beneficiary of extraordinary unearned good luck for most of a generation.”
By the mid-90s, you could already make an excellent case for fast-rising corporate profits being down to falling interest rates (which made corporate debt cheaper), falling corporate tax rates (which obviously bump up post-tax profits) and falling depreciation charges (a result of not investing much).
Since then, it’s been more of the same. Interest rates have been consistently “gerrymandered” down. Company executives have been incentivised, by ludicrous profit-related stock option awards, to avoid investing at all costs. This keeps depreciation low, profits high and bonuses at levels that allow the heads of big companies to transform the fortunes of their families for generations after only a few years as chief executive.
There has also been an unprecedented rise in total debt (state and personal), something that shows a long-term and very close correlation with rising profits.
So to the point. All these distortions look very much like things that will revert to some kind of mean at some point. Let’s start with corporate taxes.
They’ve been coming down for some time, and at the same time, they have become rather easier for footloose companies to avoid. Governments and taxpayers are slowly losing patience with this – surely rates and levels of anti-avoidance regulation are more likely to rise than fall?
Note too that there have been several calls recently for large companies to be taxed on their unused cash piles.
Next, interest rates. They have to normalise at some point. Then there is the high level of both public and private debt. Western governments may like to think it can grow for ever, but would you want to bet on that?
There is, finally, a move to do something about the way in which executives are paid. This is all going to take a while to play out, but in the meantime, if big companies want to see revenue growth, there is going to have to be some wage growth. After all, if consumers are already maxed out on borrowing, only rising wages can get them spending again.
So, what’s a reasonable estimate of what a more normal world will look like? In the US, says Bennett, labour will be taking its long-term slice of value added – which is about 8% more than now, and US corporate profit margins should be about half their normal level.
The great swings in the relationships between the likes of profit shares and labour shares take decades to play out. Look back to press reports from the 1960s and you will see many of the same kinds of articles you see in the papers today – in 1963 the (generally right-wing) Statist magazine insisted that a new minimum wage policy was a must, and that the government was “irrevocably committed to doing something for the low paid”.
The low-paid did something for themselves in the 1970s. Unions used their muscle, labour grabbed back profit share, depreciation started to head up and profits fell. I don’t have any particular problem with any of that. It’s all good news.
But if you hold US equities, you might want to bear it in mind. They are exceptionally expensive on most measures.
You can, as ever, produce endless charts adjusted for everything under the sun to show that they are justifiably expensive or even reasonable on some kind of nonsensical measure or another. But it simply isn’t so. And if it simply isn’t so at a time when the great sweep of history is about to dismantle the constantly extrapolated profit margins that are the only excuse for holding them, it would seem wise to me for long-term investors to hold something else.
Anyone on my side in the search for value might look over to Russia. Thanks to the mini-emerging-market crisis, the JPMorgan Russian Securities Investment Trust is even cheaper than it was last time I suggested it.
Yes, of course it is risky, but I’d rather hold something priced for failure which might not come than something priced for perfection that definitely won’t.
• This article was first published in the Financial Times.