One of the primary reasons why I became bearish in early 2007 was due to the ever expanding operating margins of S&P 500 companies. In 2007 operating margins were at an unsustainably high level of 8%. While I never could have imagined what would unfold over the following two years I did know one thing was almost guaranteed to occur: margins would contract towards more historically sustainable levels and corporate profits would follow which would likely lead to lower or flat stock prices.
Currently, the operating margin of your average S&P 500 company is about 5%. The gray lines in the chart below represent major market bottoms following recessions. We’re currently well off the high, but not quite at the historical trough of 4% that we’ve seen during past major market bottoms. I believe we have seen the majority of the margin contraction and could very well be nearing a trough, however, I would be more inclined to say that we will experience a 1975 type recovery rather than a 1991 type recovery. There are just too many headwinds looking out at the next few years before we can see substantial margin expansion.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
simon
Warren Brusse, author of The Great Depression of Debt, has an interesting formula for how to price the S&P. His book and blog are worth checking:
https://wbrussee.wordpress.com/
Cheers for the PC.