The stock market was lifted in the last two trading days. Larry Hatheway, an economist at UBS, says economic growth means companies selling more things. But he thinks that is not as important as it used to be to generating the profits needed to send stocks higher. That's because U.S. firms have mastered the art of pulling more and more money from each dollar of sales.
One gauge of that success: Corporate margins, or profits per sale, are hovering near 12 percent now, by one measure -- tantalizingly close to a half-century high.
As discussed earlier, companies maintain profitability in current economic situation by means of improving operating efficiency. While the long term driving force for corporate earnings is technology innovation, short term measure is to boost profit margin when there is no room for revenue growth. During the economy booming time, proliferation of bureaucracy is inevitable in both private and government sector. The faster growth in economy usually can outweigh the negative impact of bureaucracy. However, when the economic growth reverses to recession, it would be difficult to shrink government human resources expense due to the bureaucratic hierarchy. Some private sectors may encounter great resistance from privileged parties such as top management of financial firms, etc. However, the majority of private sector are under the pressure of minority and major shareholders for public companies and the owners of private companies to maintain profitability and as a result dividend. The most effective means is through downsizing. If executed properly, the impact on productivity should be minimal because it can be achieved by squeezing the already swollen corporate hierarchy. There would be social impact but corporations are more concerned on its own existence.
Some investors with cash on the sideline are turning optimistic with the upbeat results of corporate earning. The volume of trading is slightly higher than the recent average. This may be the start of a slow market upward movement replicating the pattern during the period from early February to late April in this year. Retail and institutional investors as well as day traders buy up the stock market with light trading volume. It is cautiously optimistic on stock market and the trading portfolio is bullish with hedging on surprise downtrend.
Not everyone is convinced. Legendary investor Jeremy Grantham, the Boston money manager who called the housing bust years ago, has been telling investors for months now that profit margins will fall from their perch, sending stocks tumbling. Andrew Smithers of London researcher Smithers & Co. wrote a report warning of the same. John Hussman of the Hussman Funds wrote this month that investors buying stocks on the belief that fat margins will last are destined to "walk themselves over a cliff."
"The dark side of margins is that they're going to have to come down," says Claus Vistesen, an economist at the University of Hull in England. He adds, ominously, "And the market hasn't fully priced this."
The analyst comments in opening and ending paragraphs are quoted from Yahoo! Finance "How profits, stocks can rise as economy stumbles" published On Sunday July 25, 2010, 1:01 pm EDT.
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