Much of the expected increase in profits are based on further improvement in margins. Question is whether current forecasts will hold. The margin revision trend so far has been quite negative.
March 18, 2014:
“Profit margins for the broad market and most sectors stand at record high levels. Managements have been struggling to maintain current margins, a point that was made abundantly clear on the recent quarterly conference calls.” (Goldman Sachs)
Will current high margins mean revert or could they be considered to have found a new permanent level.
“In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well. In addition, there’s a public-policy point: If corporate investors, in aggregate, are going to eat an ever-growing portion of the American economic pie, some other group will have to settle for a smaller portion. That would justifiably raise political problems—and in my view a major reslicing of the pie just isn’t going to happen.” (Warren Buffet)
Current stock market valuations, as measured by price-to-earnings, are very high and profit margins have been soaring. If profit margins were to revert back even to the top end of their historical range, the resulting decline in profits would mean valuations would become be even more elevated than they are today.
“I’ve noted frequently that after-tax corporate profits as a share of national income are about 70% above historical norms; that these profit shares are heavily mean-reverting and strongly (inversely) associated with subsequent profit growth over the following 3-4 year period; and that the current surplus of corporate profits is the mirror-image of corresponding deficits in household and government savings. Recent profits data, as well as the entire historical record, are tightly explained by these factors.” (John P. Hussman)