U.S. corporate profit margins are already narrowing, but bottom up forecasts are looking for an aggressive move out to new highs in the coming quarters.
Given U.S. labor cost inflation, revenues need to snapback from their current contraction to achieve even modest margin expansion. The growth backdrop is not conducive to such a development. The yield curve, which is an excellent business cycle indicator and a leading signal for profit margins, continues to flatten relentlessly.
Fewer than 50% of the non-financial and non-utility industry groups are currently expanding profit margins. Yet 8 out of 10 sectors are expected to grow margins according to analyst earnings estimates.
Specifically, cyclical sectors such as industrials, materials, energy and technology are slated to show broad-based improvement in profitability. That would not be farfetched if the world were on the cusp of a V-shaped, post-recession type of acceleration and the U.S. dollar were set to weaken significantly, i.e. more than 10%. After all, cyclical sector profit margins are very depressed.
However, deleveraging and the global credit contraction warn that global growth is not about to rebound. As such, our U.S. equity strategists remain skeptical that the macro backdrop will validate upbeat analyst forecasts, rendering the broad market vulnerable.