May 1, 2014

Corporate profit margin concerns

Corporate profits are the mother's milk of stock prices. First, we've had this lengthy improvement in corporate productivity, and that's likely near complete. We've had years of fixed-cost reductions by corporations, and that's also likely over, because they've cut to the bone. If the employment market gradually tightens, labor costs will rise, pressuring margins. Both interest expenses and effective tax rates will have to rise as central banks normalize monetary policy and the U.S. sees the need to reduce its deficit. And a very costly regulatory policy is likely to continue, increasing corporate costs. And finally, the quiescent capital-spending cycle will ultimately be awakened. With that, amortization and depreciation costs will ascend.

We are in a market with no memory from day to day, sometimes from hour to hour. But we are seeing the rotation that we began to see between 1999 and 2000. Warren Buffett was really out of favor when, during the technology and Internet boom in 1997, '98, and '99, people said he had lost his touch. Value stocks were out of favor and tech stocks were in favor, but then, all of a sudden at the beginning of 2000, you began to see a rotation out of high-beta, high-octane stocks, which eventually collapsed into value stocks. In early 2000, that move presaged a late-2000 considerable decline. So, we are moving from a one-way market to a two-way market where you can make money both long and short.