Amid historic inflation, Fed likely to keep interest rates higher until corporate profit margins crack

Rising corporate profit has accounted for almost half the spike in euro zone inflation since the start of 2022, according to the IMF. Labor costs contributed 25% to price growth during a period when euro zone inflation reached stunning 10.6%. The U.S. experienced a similar trend. In both 2021 and 2022, corporate profit as a share of U.S. gross domestic income (GDP) touched the highest level since 1966 as historic inflation jumped to 9.1% from just 1.2% in October 2020.

Francesco Guerrera for Reuters:
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Excluding the “Magnificent Seven” – Alphabet, Amazon.com, Apple, Meta, Microsoft, Nvidia, and Tesla – the margin for S&P 500 members is 11.6%, about 1 percentage point below its all-time high. It’s a more comforting calculation for [U.S. Fed Chairman Jerome] Powell than it is for equity investors anticipating a record-breaking run predicated on a roughly 25% uplift in earnings between now and 2025, according to Wall Street analysts. Expanded margins will have to play their part.

Big Tech may be able to power growth in earnings and margins on their own, especially if artificial-intelligence breakthroughs live up to the hype. At Facebook owner Meta, for one, analysts expect earnings per share to rise 34% this year and its EBITDA margin to jump to 51% from 43% last year, based on estimates gathered by LSEG.

Overall, however, the operating margin for companies in the STOXX Europe 600 Index is expected to contract to 8.5% at the end of 2024 from about 9.8% now, Bank of America analysts reckon. If that’s the trajectory, it is hard to see how shares will keep rallying from record to record.

Whether or not Powell, [European Central Bank chief Christine] Lagarde, and [Bank of England Governor Andrew] Bailey are willing to say it explicitly, this sort of drop-off is what they would like to achieve. And they probably will keep interest rates higher until they see corporate profit margins cracking. “Don’t fight the Fed,” renowned investor Marty Zweig warned the market in 1970 to help explain the correlation between central bank policy and the movement of stock prices. The same principle applies for today’s CEOs.

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MacDailyNews Take: A premature rate cut by the Fed is of higher probability in an election year.

As for corporate profit margins, Apple is a special case with enviable margins. Apple’s gross profits margins for the last four quarters: 42.96%, 42.26%, 43.26%, and 43.75%.
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