Corporate profits have been artificially inflated and are ready for a tumble. From Charles Hugh Smith at oftwominds.com:
Should stock valuations track this same decline in profits, it’s entirely reasonable to expect the stock market to lose 2/3 of its valuation premium.
All Six of the reasons corporate profits will decline by half are common sense:
1. Reversion to the mean: profits that are double the historical average as a percentage of Gross Domestic Product (GDP) are highly likely not to be a sustainable New Normal. The far more likely track is a reversion to the historical average, which is about 50% below corporate profits’ current 12% of GDP. Permanently elevated plateaus of stock valuations and corporate profits are both compelling chimera. (see chart below)
2. The Boost phase of Globalization has ended. The era of hyper-globalization is clearly visible on the charts of corporate profits and corporate profits as a percentage of GDP: right after China was accepted into the WTO in 2001, US corporate profits skyrocketed in both nominal dollars and as a percentage of the US economy (GDP).
Globalization’s boost phase that sent corporate profits into orbit has rounded the S-Curve and is now in the stagnation / decline phase. (see chart below)
The reasons why hyper-globalization rocketed corporate profits to unprecedented heights are both well-known and terribly inconvenient to the happy story that globalization will magically generate unprecedented profits forever.
The primary drivers were global labor and environmental arbitrage, a.k.a. exploit cheap labor in sweatshops and dump all the toxic waste of industrialization in developing nations with lax environmental standards and enforcement. As the chart below shows, wages in China are no longer low, and China has begun improving its environmental standards.
