The S&P 500 just posted its best earnings season since 2010, a feat achieved thanks to huge corporate tax cuts provided by the Trump administration. But profit margin growth is now headed for a slowdown, Goldman Sachs strategists say in a new report, thanks to wage growth and higher interest rates at home, as well as a slowdown in growth overseas.
Notably, all of the technology firms, along with their “adjuncts,” account for all of the increase in S&P 500 profit margins over the past two decades.
“Information technology sector accounts for 60% of the increase in S&P 500 profit margins over the past 20 years, while the “adjacent tech” sector—comprising the health care (including biotech firms) and consumer discretionary sectors (incl. firms such as Booking Holdings and Expedia) accounts for 40% of the rise,” according to the report.
With signs that exceptionally fast global economic growth seen last year is going to moderate, as well as an assumption that the sluggish wage growth in the US will tic up slightly, any significant pickup in profit margins is unlikely.
“We assume a hot labor market where (1) wages rise 1 percentage point faster than expected by mid-2019 and (2) the Fed hikes the funds rate twice a quarter in 2019H2. Profit margins already peak this year and are 1pp lower by end-2020 than in the baseline. Higher wage growth and higher interest rates both weigh significantly on nonfinancial corporate margins because compensation accounts for almost 60% of gross value added and because leverage is now about 20% higher than in 2005,” the strategists write.
“We assume turmoil abroad causes (1) a 1.25pp miss in foreign growth, (2) a 0.4pp miss in US growth (reflecting the hit to exports, for instance in a severe trade war), and (3) the Fed to hike two times less than in our baseline,” they added.