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A corporate squeeze?

This long cycle has seen good rises in turnover and company profits overall, especially in the large US market.

by
John Redwood

in Features

30.10.2019

In the US, the giants of the technology world have flourished, hoovering up revenue in many parts of the world from traditional businesses. Amazon has captured sales from shops, Netflix from media companies and Facebook from advertising agencies. Individual older companies and sectors have often been on the wrong end of this transformation, but overall markets have been sustained by higher revenues and profits.

Today there is a profits slowdown underway. Banks struggle to make good money with low-interest rates. Oil and other commodity prices are quite weak limiting profits from resource companies. Traditional businesses under a competitive cosh from technology see declining profits. Even some of the technology companies themselves now face a greater challenge to boost net income. Governments worldwide want to tax them more. New challengers to their businesses seek to cut their prices and revenues. Regulators move in and force them to increase costs to meet new higher standards of conduct. The costs of expansion also make an impact on their published results.  Over the last few days, we have seen good revenue growth continuing from Google and Amazon, but rising costs and higher taxes stop this good news filtering through to earnings.

Slowdown an issue?

So how seriously should we take a possible challenge to corporate profitability? Is this is a modest slowdown lasting for a year or so, or is this some change of trend we should worry about?  Usually, profits fall drastically for a market as a whole only when the host economy or the world economy goes into recession. If the overall output and incomes are falling then the average company may well experience falling turnover. With high levels of operational gearing and often with financial gearing as well, profits can be badly hit by a fall in sales. Is it possible for there to be a profit reversal whilst the world economy still advances, and whilst aggregate incomes generate more sales revenue overall?

There are plenty of demands being made on corporate profits we need to consider. Governments want to spend more on a variety of purposes and eye the profits and cash flow of the company sector with avarice. It is true some are engaged in a collective game of cutting corporation tax rates to make themselves more attractive to inward investors, on the grounds that a smaller share of a bigger volume of profits is good for them individually. We have seen the USA, UK, India and others cut their rates for this reason. It is also true that governments generally are looking for ways to achieve a bigger overall tax take from the corporate sector. Various levies are being imposed in the name of greenery or health or other reasons to take money away. There are sugar taxes and energy taxes and transactions taxes that governments impose. Fines on companies for bad conduct have become a useful source of revenue. There is a tendency to try to effect social change by pressurising companies to change their conduct through tax and regulation. There is less adverse political reaction to this than from forcing individual consumers to change their conduct more directly.

Wages vital

There are demands from individuals often supported by governments to raise wages, especially at the bottom end of the income distribution. In much of the advanced world real incomes have stagnated or grown very little in recent years, so there is pressure to improve. However, the pace of technology allowing greater substitution for manpower, and the ready supply of cheaper labour from migrants or from imported goods and services still restrains growth.  There are demands from Regulators, which is resulting in a big increase in the cost base of many companies as they work to comply. The digital publishers, for example, who used to be able to publish anything and claim it was not their material now have to spend money and time removing unacceptable content.

Overall it seems likely that world growth next year can see some modest increase in profits again after the current slowdown. Low-interest rates and cheap capital help.  Real wages are still struggling to grow given productivity problems and the supply of alternative labour. Regulatory costs will grow but they take time to catch up with the fastest growing and most exciting new businesses. Governments will still find there are limits to how far they can go in imposing additional taxes on footloose companies with some accounting flexibility. Shares have got dearer this year relative to profits and this limits their potential in the months ahead. Given the wish of the main Central Banks and governments to avoid recession it looks as if shares like economies can carry on muddling through.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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