Margins facing squeeze as demand grows for wage rises
Robust corporate profit margins, one of the underpinnings of the rally in developed market stocks over the past decade, could be put to the test in coming quarters as tighter labour markets push companies to hike wages at last to stay competitive.
Slack in job markets, stubbornly low inflation and the disruptive effect of technology across industries from retailing to financial services, along with off-shoring of manufacturing to low-cost locations, have kept wage growth subdued and profit margins high across markets in the United States, western Europe and the advanced economies of Asia.
Fat profit margins have lifted global stock markets to all-time highs. Yet wage growth remains well below average levels, giving credence to the old investment adage that what is good for shareholders is bad for employees.
Now, with most developed markets running at or near full employment, and with inflation potentially lurking around the corner, market participants say that companies are now likely to face rising pressure to raise wages.
Corporate profit margins in the United States will be a key area to watch as the second-quarter results season gets underway this week.
American companies' operating profit margins are currently running close to 20pc, according to Thomson Reuters data, which is only slightly below the peaks seen in 2001 and 2007.
Higher wages and declining productivity are likely to eat into corporate margins throughout the rest of this year and next as companies pay more to recruit and train workers at a time when unemployment is near multi-year lows, said Phil Orlando, chief equity strategist at Federated Investors in New York.
Global profit growth, currently running at about 10pc, has far outpaced sales growth, which is less than half that, according to Thomson Reuters data.
The difference points to profit growth being boosted in part by cost-cutting.
However, a global recovery in economic growth is gathering steam and points to demand finally picking up.
"This is the first year of a synchronised global recovery and a lot of the profit growth we're seeing is because of actual demand increasing, and not just cost cuts," said Dale Winner, a fund manager who runs a portfolio of global stocks at Wells Fargo Asset Management.
"Wage growth will pick up, albeit at a moderate pace," he added.
Investors are likely to increasingly distinguish, however, between companies and sectors that are able to pass on costs of a higher wage bill to their customers and protect margins versus those that will have to take the hit.
The crunch will hurt low-margin businesses like supermarkets the most, while leaving technology companies with larger margins - such as Microsoft or Oracle - relatively unscathed, Mr Orlando said.
"If there's a trade-off between a faster-growing economy and rising wages hitting margins, I will take the faster-growing economy in a heartbeat," he added. (© Reuters)