Hussman: Margin Argument Doesn't Hold Water

Could historically high profit margins be the result of more foreign profits, making the high margins a new reality rather than anomaly? Fund manager John Hussman says the data says ‘no’.

“The bottom line is simple,” Hussman writes in his latest market commentary. “Corporate after-tax profits as a share of GDP, GNP (or even net national product if one wishes to use that number) are steeply above historical norms, and the pre-tax profit share is also at record levels. This fact can be fully explained by mirror image deficits in household and government saving — a relationship that can be demonstrated across decades of historical evidence. As a result of a severe credit crisis and a sustained period of lackluster economic activity, we’ve seen a fiscal deficit (elevated transfer payments to households and shortfalls in tax revenue) combined with weak household saving. The combined effect is that companies have been able to maintain revenues while paying a very low share of income to labor and taxes.” He adds, “The role of international activity on profit margins is strictly secondary.”

As for Hussman’s outlook, it remains negative — for now. “We continue to view stocks as strenuously overvalued, but that alone does not drive our investment stance,” he says. “What concerns us beyond valuations is the full ensemble of overvalued, overbought, overbullish conditions, coupled with textbook speculative features (soaring margin debt, heavy issuance of low-grade ‘covenant lite’ debt, heavy initial public offerings of speculative companies), and growing internal divergences in price action and leadership. Our avoidance of market risk, and tightly hedged investment stance, does not reflect expectations of immediate market losses in this specific instance, but instead reflects the experience of severe average losses when similar conditions have been observed in a century of historical data.” Hussman adds, however, that he is still “very optimistic about the prospects for remarkably better investment opportunities over the completion of the present market cycle and beyond. Our concerns about present conditions should not dim our enthusiasm about the longer-term outlook, provided that we maintain patience, and insist on accepting significant investment exposure only at points when risk is associated with strong expected returns.”