9.3%
1999
Declining Share, Declining Shares?
Corporate profits have been sinking as a share of GDP. Some analysts fear
that stocks will follow suit.SOURCE: FEDERAL RESERVE BANK OF ST. LOUIS
U.S. CORPORATE PROFITS AS A PERCENTAGE OF GDP
0
2
4
6
8
10
12%
2005 2010 2015 ’18
81
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rates at which workers are leaving jobs for
new ones are why wages are growing at 3.1%,
twice the pace of 2010. Ordinarily, these trends
would continue pressuring profits, and sup-
pressing share prices, across the economy.
But there’s one investor who thinks we may
have entered a new normal that could sustain
higher profitability for a long time—and
that investor, surprisingly enough, is Warren
Buffett. At the 2018 annual investor meeting
for Berkshire Hathaway, Buffett acknowl-
edged that the Internet, social media, and
data revolutions have spawned an “asset-light
economy,” driven by tech giants that generate
floods of profits from mere trickles of capital.
Amazon, Apple, Google parent Alphabet,
Facebook, and Microsoft dominate their in-
dustries, and their powerful brands and enor-
mous scale swell their revenues per customer
and lower their costs of attracting new ones.
It’s not coincidental that those five companies
now account for 12% of the S&P 500’s profits.
While they, too, face rising labor costs, they
don’t need nearly as much labor (or plants, or
inventories) to generate hefty sales.
The takeaway: The profitability of the
tech titans will decline more gradually than
margins in other industries, which should help
their stocks outperform too. Overall U.S. stock
returns will likely be lower than what investors
have grown used to. But if workers pocketing
higher wages are a reason for that slowdown,
that will be a silver lining. —Shawn Tullyeasy for investors to tell how much companies
have borrowed. And bank debt is more likely
to be “variable rate,” meaning that interest
payments on the loans go up if rates rise more
broadly in the market.
To reduce exposure to corporate debt if
rates spike, Tom Graff, head of fixed income
and a portfolio manager at Brown Advisory,
suggests steering clear of bond ETFs, whose
prices could get very volatile if investors
stampede out when interest rates rise. (Try
open-end mutual funds or direct bond buy-
ing instead.) And in both the bond and stock
markets, look for clean balance sheets: If a
company has a heavy debt load, now’s a good
time to walk on by. ÑErik Sherman
Corporate Profits
AS WORKERS GET MORE,
SHAREHOLDERS COULD GET LESS
FOR DECADES, it’s been one of Warren Buffett’s
guiding principles: When corporate profits
swell to a disproportionately large share of
GDP, the Omaha sage has cautioned, the
competitive nature of capitalism exercises
a gravitational force that pulls them back to
historical norms. Profitability shrinks, and
stock returns become sluggish, or worse.
If that principle holds true, investors could
be facing a rough ride. By some measures,
Buffett’s gravitational shift is already under-
way. U.S. earnings peaked at 11% of GDP in
2012, but in the fourth quarter of 2018, they
still accounted for 9.3%, or 2.6 percentage
points higher than the 60-year average (see
chart), suggesting they have further to fall.
Analysts polled by FactSet forecast a year-
over-year decline in earnings per share for the
S&P 500 of 4.2% in the first quarter, and zero
growth in the second.
The change reflects a tipping of the balance
back toward labor. Since 2000, the share of
GDP going to salaries, wages, and bonuses has
dropped from 46% to 43%; lately, that trend
is reversing. “America now has 7 million job
openings, more than one for every unemployed
worker,” says Ryan Sweet of Moody’s Analytics.
That tightening labor market and the increased
“GDP
doesn’t
tell you if
a project
is good or
bad, or if
services
are useful,”
says one
China
expert.