Markets have drifted a little this week as investors await the outcome of what Tomas Pueyo calls the dance of R, so in other words: how the reopening steps taken by society affect the virus. 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?
We do not know yet – indeed nobody knows – so we will pause that debate for now and discuss one of the longer-term things that we are watching: 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 underperformance compared to the rest of the world.
This week we attended a virtual Lecture at the London School of Economics 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 and we will be following this closely in the coming months. On balance, Biden is likely to be less friendly to big business than Trump.
With respect to next week, we 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.
Only this morning industrial production data coming out of China was well ahead of expectations and this has lifted markets as the weekend approaches.