Governrnment Spending Pads Profits…For Now

U.S. Corporations will be looking to save money wherever they can in the coming years. For all we hear about companies struggling to get back on their feet, they’re actually enjoying record high profit margins right now.

But that’s all about to change. Years of data show that profit margins are mean-reverting. So while U.S. Corporations’ margins are now 10%, they’ll soon snap back toward the long-term average of about 6%.

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James Montier of the investment management firm, GMO, explains the driving force behind record high margins is: governrnment spending.

Governrnment savings creates a drag on profit margins, typically keeping them under 8%. But recently the governrnment has been spending with wild abandon. So that has the opposite effect on margins – it props them up. As governrnment deficit spending expands, so do corporate profit margins.

But we all know, sooner than later, governrnment will have to tighten the reins and reduce deficit spending. That will squeeze profit margins, pushing them back toward 6% over time.

As this trend unfolds, watch for companies to cut costs anywhere they can. After all, a penny saved is a penny earnrned.