16 January 2007
Gerard Minack --Crash a coming
Courtesy Gerard Minack Morgan Stanley Sydney"I keep insisting that equity markets are a bubble,but not a TMT-like PE bubble, an earnings bubble.Look at the US as an example. US earnings per shareare now almost 70% above their long-term trend(Exhibit 1). Earnings haven't been that far above trendin a long time – since 1916, in fact. In other words, thissort of bubble is rarer than a 5-0 Ashes whitewash.The earnings surge has taken the after-tax profit shareof GDP to a post-1945 high. The profit-share is 54%above its long-term average. The only time the profitshare has been further above its average was in 1929.This is bearish big-picture stuff – so long as you believethat returns (or profit share) mean-revert. The counterargumentis that in a globalized world it makes nosense to compare profits of US firms, which can beearned anywhere in the world, to US GDP. In fact, it'sworth noting that 1916 – when EPS saw its largest-evergap to the trend – was at the end of the great Victorianera of globalization. In other words, globalizationremoves or loosens domestic constraints on profits.However, I'm not so sure it is the principal reason whymargins are so now high, at least in the US. Here are afew points to note:First, note that even after adjusting for the profits USfirms make on their offshore sales, margins on sales inthe US are around post-1945 highs.Exhibit 2 shows two series. One is after-tax profits ofUS corporates (relative to corporate GDP), whichreflects their US-sourced earnings, as well as profitsmade offshore. The second is profits earned in the US,which includes the profits made by non-US firmsoperating in America.