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The major drivers of high U.S. corporate profit margins are unsustainable and “now under threat”, which will eventually result in much lower equity prices, Bridgewater Associates, the world’s largest hedge fund, said on Wednesday in a report.
“Over the last two decades, U.S. corporate profit margins have surged and have contributed more than half of the excess return of equities relative to cash,” said Bridgewater, which oversees more than $160 billion in assets.
“Without that consistent expansion of margins, U.S. equities would be 40% lower than they are today.”
Over the last few decades, almost every major driver of profit margins has improved, Bridgewater said.
“Labor’s bargaining power fell, corporate taxes fell, tariffs fell, globalization increased, technology allowed for greater scale and lower marginal costs, anti-trust enforcement fell, and interest rates fell. These factors have produced the most pro corporate environment in history. Many of these drivers of high profit margins are now under threat.”
“Some of the forces that supported margins over the last 20 years are unlikely to provide a continued boost,” Bridgewater said. “Incentives for offshore production have been reduced as global labor costs have moved closer to equilibrium, with domestic costs and rising trade conflict increasing the risk of offshoring, while the potential tax rate arbitrage from moving abroad is now much smaller.”
At the same time, popular sentiment has begun to turn against the forces driving corporate profits, as well as against the companies that have benefited most, Bridgewater said.
“We are in the midst of a populist backlash against rising inequality and increasingly seeing a move toward more protectionism,” it said in the report. “Recent surveys show increasing animosity toward globalization and the power of companies more broadly and a bit more welcoming attitudes toward government regulation of firms.”
There is also more discussion about taxing mega-profitable firms that have benefited from current government policies, it said.
For example, Europe’s potential “digital services tax” is explicitly designed to close the tax arbitrage by introducing a sales tax on online revenues from residents.
“While the current impact of these proposed rules on the overall profitability of these tech giants is relatively small, they are a straw in the wind that the tide might be turning and that the multi-decade boost from favorable taxation policies is unlikely to be repeated,” Bridgewater said.
