America’s stock market rally is on borrowed time

American corporate profits appear to be “running out of steam”, says Buttonwood in The Economist. They had recovered after the crisis and are close to a post-war record as a proportion of GDP.

But first-quarter S&P 500 earnings estimates were revised down by more than 4% between January and March, and profit warnings have been unusually plentiful.

Remove the effect of one-off items, such as a big write-downs the year before, and you will see that year-on-year profit growth is falling, according to Morgan Stanley Capital International. And a quick rebound looks unlikely.

While revenue growth has been gradual, profit margins are near record highs and due to fall, says Doug Kass of Seabreeze Partners Management. “We’ve had years of fixed-cost reductions by corporations and that’s basically over, because they’ve cut to the bone.”

There is scant additional scope for bolstering productivity and the labour market should gradually tighten, raising staff costs. The picture in America, which sets the tone for
world markets, isn’t offset by especially strong outlooks elsewhere.

In Britain and the eurozone strong currencies weigh on earnings. In Europe this helps explain why profits have yet to rebound convincingly despite the economic recovery.

In many stock markets, companies derive a growing proportion of profits from emerging economies, many of which have been slowing and undermining multinational companies’ earnings through falls in their currencies.

Operating profits chartInterest rates in America and elsewhere in the developed world are set to rise in the next few years, and this would add another cost for corporations, many of whom still have large debt burdens.

All this adds up to a lacklustre future backdrop for global profit growth, which has already disappointed: in 2013, it reached 7%, compared to forecasts of 12% at the beginning of the year; in 2012 it hit just 2%, while the initial estimate was 11%.

Global stock markets have been “remarkably resilient” despite unimpressive earnings, soaring by 13% and 24% in 2012 and 2013 respectively, says Buttonwood.

But lacklustre earnings are now going to become ever harder for investors to ignore – which is another reason to fear that this rally, already the fourth biggest and fifth longest for the S&P 500 since 1928, is on borrowed time.