Market Update
May 15, 2020

Why do US companies make so much money?

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As investors await the outcome of how the reopening steps taken by society affect the virus, markets have drifted a little this week.

Does the virus win and will society have to lock down again or do countries around the world successfully navigate the labyrinth of opening up and find a clean way out?

Nobody knows the answer to this question yet but there is another question, albeit a more long-term question, to discuss: US profit margins. Why are they so high compared to the rest of the world? This question has obvious implications for asset allocation. If margins stay high, then it is likely that the US stock market will continue to outperform. However, if US margins come under pressure compared to non-US margins then it is likely that the US stock market could be in for a period of under-performance compared to the rest of the world.

The great reversal

This week London School of Economics hosted a virtual lecture on this very topic. The title of the lecture was “The Great Reversal”. Thomas Philippon, currently a professor of finance at the Stern School of Business in New York, gave the lecture and he has just written a book of the same name so has studied this issue in detail.

He listed a fascinating oddity of the world in which we live, where so many things are more expensive in the US than, for instance, in Europe. Just one example he gave was the price of a mobile phone calling plan, which is twice as high in the US as in Europe. If this were an isolated event one could disregard it, but he has found several examples across a range of industries and believes that this is due to less competition in the US than say in Europe.

This is a massive reversal compared to thirty years ago, but his analysis shows that the European Union has been very successful at introducing more competition into European economies whereas lobbyists have been very good at lobbying for big business in the US economy.

So, if this is one of the reasons for high profit margins in the US investors should look at what the presidential candidates are saying on this topic. On balance, Biden is likely to be less friendly to big business than Trump.

The week ahead

With respect to next week, investors will be watching any news on China GDP growth targets like a hawk. These data points are scheduled to be announced at the end of the week.

Data on global industrial production, which is likely to come out in the next eight weeks, will show a dramatic improvement. Only this morning industrial production data coming out of China was well ahead of expectations and this has lifted markets as the weekend approaches. Therefore, investors may wish to consider retaining exposure to equities in the coming months.

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