Six Reasons Why Corporate Profits Will Fall 50%
Should stock valuations track this same decline in profits, it's entirely reasonable to expect the stock market to lose 2/3 of its valuation premium.
Globalization's boost phase that sent corporate profits into orbit has rounded the S-Curve and is now in the stagnation / decline phase. (see chart below)
The reasons why hyper-globalization rocketed corporate profits to unprecedented heights are both well-known and terribly inconvenient to the happy story that globalization will magically generate unprecedented profits forever.
The primary drivers were global labor and environmental arbitrage, a.k.a. exploit cheap labor in sweatshops and dump all the toxic waste of industrialization in developing nations with lax environmental standards and enforcement. As the chart below shows, wages in China are no longer low, and China has begun improving its environmental standards.
Hyper-globalization provided the ideal cover for the systemic collapse of quality and durability. This corporate institutionalization of planned obsolescence, abysmal quality and shrinkflation all boosted profits enormously, but there's nothing left at the bottom of the barrel; corporations have licked the profitable slop of planned obsolescence, abysmal quality and shrinkflation clean.
The super-efficient global supply chains are also breaking under the strain of geopolitical and national security priorities, and the difficulties of replacing existing supply chains, which depend on cheap energy and transport and a massive infrastructure to serve trade that non-industrialized developing nations cannot duplicate.
Now that zero-interest rate policy (ZIRP) has ended its disruptive reign, the tailwinds of zero rates have reversed into the headwinds of structurally higher rates.
Since growth depends on the ceaseless expansion of debt and the discretionary spending it enables, growth reverses along with discretionary spending. Corporations will find it impossible to keep prices at nosebleed levels as consumer demand plummets while costs remain sticky.
Rather than being the New Normal, corporations skimming 11% of GDP as profits was a one-time outlier resulting from the one-time boost of hyper-financialization, hyper-globalization and ZIRP. US GDP is around $26 trillionaccording to the Bureau of Economic Analysis (BEA). Corporate profits sagged a bit to $3.2 trillion in Q1 2023, roughly 12.3% of GDP.
Should profits decline to 5% of GDP ($1.3 trillion), this would be in the middle of the historic range. In a real recession, they could dip to 3% of GDP ($800 billion). At 5% of GDP ($1.3 trillion), corporations would still be making money but not at rates that would justify today's absurdly overvalued stock valuations.
The $2 trillion haircut equates to a 2/3 decline. Should stock valuations track this same decline in profits, it's entirely reasonable to expect the stock market to lose 2/3 of its valuation premium--a premium based not on anything remotely sustainable, but on a one-off of hyper-financialization, hyper-globalization and zero interest rates.
There's nothing wrong with a 5% of GDP run-rate for coporate profits. That's still a very healthy return. It's only a disaster in a highly distorted funhouse whose players have lost touch with reality.
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