Monday, March 26, 2012

Manufacturers' Profits: Stock-Market Trouble?

The Lehmann Letter (SM)

Manufacturers' profits are not closely followed in the news media, but today's Census Bureau report is worth noting:

As you can see from the charts, manufacturers' profits and profit margins recovered strongly from the recession and are now at record highs. You can also see the strong growth trend over the past 20 years. This is especially striking for profit margins because margins exclude all sales-volume growth. For decades manufacturers earned six cents on each dollar of sales. Lately their profit margin has grown to almost ten cents. That's a remarkable gain.

Manufacturers' Profits
(Click on chart to enlarge)

(Recessions shaded)

Manufacturers' Profits Margins
(Click on chart to enlarge)

(Recessions shaded)

But the latest data from the Census Bureau show that both profits and profit margins have stalled. Total profits fell a little and margins are now slightly under nine cents. Although that's not a severe decline, it does raise a question. Are manufacturers now adding employees sufficiently rapidly to dampen productivity gains and deplete profit margins. In other words, will rising employment costs squeeze profit margins?

This is important because it's clear that the recent recession boosted productivity and profit margins when employers reduced their labor forces more rapidly than their output fell. Sad to say, it was the rise in unemployment that reduced costs and swelled margins. But that's no longer possible now that the mass layoffs are over.

If profit margins have stopped growing, what will boost total profits? Growing sales volume is the only source of potential gain. That raises the big question: Is the economy growing rapidly enough to spur sales volume and continued total-profit improvement? Or will profits top out along with profit margins?

That should be of concern to investors who are relying on earnings growth to prolong the current bull market in stocks.

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© 2012 Michael B. Lehmann

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