Unstable times
Markets may be giving the illusion of normality but they have been driven by a series of one-off events, and growth seems increasingly unsustainable. Corporations have taken advantage of very low interest rates to re-lever balance sheets, with many using the proceeds to buy back shares, thereby flattering their earnings per share numbers.
Households have resumed their accumulation of debt, in some instances exceeding previous peak levels. On the surface this may look positive but borrowing today is taking consumption from tomorrow, and again is clearly not sustainable. We do not seem to be anywhere near that Goldilocks scenario, and with bank lending back on the rise, normalising interest rates could provide a significant headwind.
Markets are now looking to fiscal stimulus to come to the rescue, and it certainly seems to be on the horizon in the US, even if the details remain extremely vague. However, the details are important. The relatively wealthy have a lower propensity to spend, so a tax cut for the rich is unlikely to have any meaningful economic impact.
At the same time, a corporation tax cut might provide another one-off boost to the earnings per share line, similar to a share buyback, but is not the sustainable growth of the top and bottom lines that is needed to justify long-term investment.
Indeed, there are many reasons to be concerned about the profit margins US corporations are currently enjoying. Rising wages and falling productivity combined with higher borrowing costs are clearly not margin-friendly, while a stronger dollar could choke off overseas sales.
Margin pressures in turn would imperil share buyback programmes. Since corporations have been the marginal buyer of US equities for the past few years, squeezed margins could have a double whammy of weakening earnings and a de-rating of equity markets.
