End of an era: The coming long-run slowdown in corporate profit growth and stock returns Research by Smolyansky Michael (2023), Principal Economist at Federal Reserve, covers #stockmarket returns decomposition, including equity premium, corporate profits, taxes, and interest rates. The analysis covers the 1989-2019 period, during which the SP500 index achieved a real rate of 5.5% p.a. (excluding dividends), while the US economy (GDP) grew at a real rate of 2.5% p.a. Where does the discrepancy come from? 🔹Interest rates & corporate tax rates have declined substantially. 🔹Lower interest rates and corporate taxes accounted for over 40% of growth in real corporate profits. 🔹Decline in interest rates explains almost all expansion in PE multiples. 🔹These two factors account for the majority of 1989-2019 stock market performance. Is this extraordinary stock market performance sustainable in the future? Stock market performance can come from either earnings growth or multiple expansions. The author argues that corporate earnings can hardly benefit from further declining tax rates or interest rates. First, the corporate profits can come from: 🔸EBIT growth. Historically, EBIT growth is lower than GDP growth, hence, the best case is that EBIT growth equals GDP growth. 🔸Decline in interest expenses relative to EBIT. Limited scope for interest rates to fall much below their 2019 level. 🔸Decrease in corporate tax rate relative to EBIT. Further cuts are unlikely given the high US debt-to-GDP ratio and high fiscal deficit. Second, the stock price growth can also come from the expansion of the PE multiple. The author writes that P/E multiples are a primary function of earnings growth expectations and discount rates (i.e. risk-free rate plus risk premium), hence: ▪️ P/E multiples expansion will be limited to interest rate cuts below 2019 levels. ▪️ Earnings growth expectations, as discussed above, are limited. Michael Smolyansky concludes that with the expected slowdown in corporate profit growth and limited expansion in PE multiples, the long-term stock returns are likely to be low. Source: FED, Michael Smolyansky / #markets #investing #stocks
End of an era: The coming long-run slowdown in corporate profit growth and stock returns
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