How High Can Corporate America Go?

published on 05 May 2017
Over the past few years, U.S. corporations that make up the S&P 500 index have seen profits on sales surge to an unprecedented 9 percent on average, a level that is 80 percent above that seen before 1997 and about 30 percent higher than the average level after 1997. It might not sound too bad, but the problem is that this profit windfall is not having the consequences it should have. High profits are supposed to encourage investments and stimulate competition, but not this time.

So this raises two questions: what's different now and will it last? According to GMO value investor Jeremy Grantham, the profit boost can be attributed to low interest rates, globalization and the fact that corporations now have more political and monopoly power. But even as the the U.S. Federal Reserve is embarking on a path toward interest rate hikes, Grantham warns that those who expect things to return to normal sooner rather than later in Corporate America may be disappointed.

In a 2016 paper, James Bessen of Boston University School of Law writes that the high profit margins enjoyed by corporations are the result of regulations designed to benefit incumbents and stifle competition. The study mentions pharmaceuticals/chemicals, petroleum refining, transportation equipment/defense, utilities and communications as the industries which are benefiting the most from the current regulatory framework. And even with Donald Trump's deregulatory agenda, chances are few changes will be made to promote competition. Making things worse is the fact that despite the Fed's moves to raise interest rates, which could bolster investments, the very lack of fresh investments is keeping interest rates in check and for them to rise, competition would need to go up. It's a vicious circle which will be very difficult and time-consuming to break out of. 

Photo: © Winston Tan / Shutterstock
Source: Reuters