Margins of error

In response to Macro Maestro's earlier post, several people gave the same response - equities' resilience makes sense because of corporate cost-cutting. (This also seems to be the argument being touted around by strategists at Citi.) They point out that during the recent recession, the US profit share increased sharply as companies slashed wages and employment. A double dip - consistent with current bond yields - would allow this process to continue, justifying current equity valuations.

This argument seems ludicrous to Macro Maestro. Yes, profit margins can rise during a recession but it's hard to see this continuing indefinitely when nominal GDP (the main determinant of profits - look at the historical correlation) is extremely weak for a prolonged time. (Profits growth roughly equals nominal GDP growth plus the change in margins.) So Macro Maestro thinks recent US profits performance is a short-term 'levels effect' as companies eliminated the inefficiencies that built up during the boom years. The US profit share is already close to its cyclical peaks and Macro Maestro finds it hard to believe this will rise further, especially if top-line earnings (nominal GDP) collapses.

Plus Macro Maestro doesn't recall Japanese corporate profits or equities performing too well during its 'lost decade'.