Everything has been written about the possible rise in US interest rates. Which will be a quarter of a point or, creatively, an eighth. Either it will crash emerging markets and bring ours back to their August 25th lows or it will be greeted by a huge yawn, if not a soar of relief at having thought about it. We don't have much to add to the debate and join the party of those who think that markets are now prepared for anything not only psychologically but also in terms of portfolio positioning. Those who should have lightened have already done so and those who have remained invested evidently believe they are ready to absorb any decision the Fed wants to take. In the end, therefore, the slowdown in China and the emerging economies will be reconciled with the good performance of America and Europe, while any rise in American interest rates will be seen as the start of a slow normalization process and not as a fatal blow. to weak growth.
Let us remember, to keep a sense of proportion, that US short-term rates will in any case be kept below the level of inflation until the end of 2017 and probably even beyond. In other words, the Fed will bring rates to two percent in two years only if inflation, in the meantime, has risen above two percent. But let us turn our gaze towards the deep future. It gives us an opportunity McKinsey study (Playing To Win. The New Global Competition For Corporate Profits) just published and freely available on the net. It is a job that required the commitment of dozens of specialists and the use of a global database that includes the history and estimates relating to almost 30 companies involved in all production sectors and in all geographical areas. McKinsey's is a great history of profits from 1980 to 2025. It is rich in data, but above all it is a precious source of reasoning and stimuli.
The conclusions he arrives at had been in the air for some time but no one, so far, had undertaken to model and quantify hypotheses that had remained at the level of intuitions. The main thesis of the study, the punch in the stomach, is that a clear separation must be made between the glorious history of profits from 1980 to today and what lies ahead for the next ten years. The total global profits, which in 1980 amounted to 2.0 trillion dollars and which at the end of 2013 had been 7.2 trillion, will be 2025 trillion at the end of 8.6. The dollars are still those of 2013 and therefore at a constant value, without the distortions caused by inflation. Profits measured are net operating profits after adjustments to the tax burden (Noplat), but the data on Ebitda and Ebit, however different in proportions, still point in the same direction. Beyond the technical aspects, the story is that of the exceptional nature and unrepeatability of what has happened since 1980, a veritable explosion of profit margins and, even more so, of final net profits. This historic phase ended two years ago for margins and will end in the near future for final earnings, which are set to grow at a modest 1.5 percent compound annual rate over the next ten years.
Note that McKinsey does not start with pessimistic assumptions about the future of global growth. The revenues of the 30 companies analysed, in fact, will grow by 40 percent over the next ten years. If profits grow much less, it will not be due to some form of secular stagnation but due to competitive pressure, the creative destruction of technology (innovative companies take home less profit than they take away from traditional companies) and the of interest rates, corporate taxes and labor costs, three cost components that have collapsed in the past 35 years and which in the next ten probably won't rise much, but which in any case will never fall again. So far McKinsey. Let us now try to make some of our considerations. The first is obvious. The history from 1980 to today is in the records, that of the next ten years is not. No matter how rigorous and serious the methodology used in forecasting, there is always an element of subjectivity and arbitrariness. Furthermore, as Donald Rumsfeld said, there are not only known unknowns (however statistically measurable) but also unknown ones, i.e. surprises. No one, in 1977, could have predicted the extent of the Chinese breakthrough the following year and the global impact it would have and will continue to have. If we watch a 1950 science fiction film today, it doesn't matter whether it is set in 1970, 2010 or 3000, because what we see is still the world of 1950, with its hopes and fears and with the men and women women of 3000 wearing make-up as was the custom in 1950. The same thing goes for serious studies that try to imagine the future.
The Limits To Growth, the famous report published in 1972 by the Club of Rome, predicted a demographic explosion, depletion of agricultural and mineral resources, famine and social collapse for the XNUMXst century. Read today, with the demographic slowdown, the overabundance of raw materials and the global obesity epidemic, the book of the Club of Rome tells us not about our present, but about the gloomy sadness and paranoia of the XNUMXs, a historical phase of stagnation, of energy crisis and social instability. The same thing, perhaps, can be said of the forecasts for the future made today, the result of the pessimism and creeping anguish of recent years. Strange years, ours, in which stock markets are at their highest not because of enthusiasm for the future, but because of the subtle desperation of central banks, which are trying to remedy the semi-stagnation, the aging of the population and the fiscal crisis with the monetization of debt, negative real rates and overabundant liquidity. That said, McKinsey's predictions are the best that can be written with the knowledge we have today and are backed by evidence for all to see.
Profits are under increasing attack from many fronts. Governments don't raise corporate taxes because they fear tax competition from other countries, but they do more and more casually the worse, bleed the banks with continuous and mammoth fines or, as we see in Germany these days, casually unloading on the electric companies and on their shareholders the costs of a nuclear decommissioning decided by politicians with electoral motivations. The large multinationals of emerging countries, for their part, can cause great damage to the profits of ours. We've seen it in the steel industry and we're seeing it in aviation (if the American and European skies were opened up to competition, we'd all be flying on Gulf airlines). The major international trade agreements under discussion, such as the Trans-Pacific Partnership, will make these forms of competition even more evident. Technology, then, does its best to eliminate the inefficiencies of the market and compress the extra profits that follow. Today, there's Skype where there used to be fat long-distance phone companies. Airbnb increases competition in the hotel sector, while used car dealers know that, before buying, everyone compares prices online. The same is happening in apparel and distribution in general and will soon happen in other sectors.
How will this slower earnings growth translate to the stock market? At first glance, considering the current level of multiples, one would think of flat bags as far as the eye can see. But we know it won't be like this because it has never been like this. The earnings explosion since 1980 has certainly been accompanied, in the long run, by an explosion in stock indices, but also by enormous volatility. The SP 500 went from 140 in 1980 to 1527 in 2000. It dropped to 798 two years later, returned to 1565 in 2007. It dropped to 666 in 2009, then climbed back to 2124 in June of this year. If in 2025 the stock exchanges will be at today's levels it will therefore be by chance, but this case will fall within the category of possible things. Even assuming 1.5 per cent annual growth in earnings and applying today's multiples to these earnings (after all, rates won't rise much) stock exchanges could still remain more attractive than bonds in the long run . In fact, 1.5 of dividends and 2.3 of inflation will have to be added to the 2.0 of earnings growth, which today seems far away and which, however, will probably be reached and surpassed. This brings us to 5.8 without counting the buy-backs, which will decrease over time but will not disappear completely. The challenge, in a world of this type, will therefore not be at the level of indices, but will consist in identifying sectors in strategic decline and emerging ones in time. The Schumpeterian creative destruction will in fact work full time.
The value added (or taken away) from individual equity managers will be exalted.
