Wednesday, May 4, 2011

Profit-Margin Squeeze?

The Lehmann Letter (SM)

Yesterday's Wall Street Journal carried an article on the profit-margin squeeze generated by world-wide price increases:

Manufacturing continues to grow while facing the following question: Can it raise prices in order to pass on cost -- especially fuel cost -- increases?

The chart indicates that this is an important question because business has benefited mightily from a 10-year surge in margins. Profit margins did not fall during the recent recession and now stand at an all-time high.

Profit Margins

(Click on chart to enlarge.)

Recessions shaded

Rising productivity is largely responsible for this trend. Management has boosted output while restraining input costs. During the recent recession and recovery businesses cut employment more than output, and then increased output more than employment, raising output per worker and profit margins.

But how long can this continue and how far can margins climb? If weak demand here at home restraints price increases while strong demand overseas raises input costs -- especially fuel costs -- then producers are in trouble. Profit margins, and eventually corporate earnings, will stop growing.

The stock market has run ahead of the overall economy, fueled by encouraging earnings reports. Those earnings and the market may hit a wall if management can't raise prices while paying more for inputs. Most of the earnings growth may very well be behind us.

(The chart was taken from [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2011 Michael B. Lehmann

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