Fed Anticipates End of Era for Stocks Amid Slowing Corporate Profit Growth
A recent whitepaper by the Federal Reserve warns of “significantly lower profit growth and stock returns in the future.” In his article, Michael Smolyansky explains how the interest and corporate tax rates trends for the last thirty years provided a strong tailwind for corporate profits. As a result, stocks performed better than would have otherwise been the case.
Understanding why corporate profits and, ultimately, stock prices outperformed in the past is essential. However, more critical for investors is the future and assessing how interest rates and tax rates will affect earnings growth and stock prices.
To expand on the article’s warning, we examine a few large well-known companies to see how lower interest and tax rates benefited their bottom lines. But first, we summarize the Fed article.
The graph below shows that corporate earnings have grown faster over the last 30 years than in the 40 years before. The robust earnings growth occurred despite economic growth shrinking markedly.
Michael’s article attributes two key factors to explain the significant disconnect between the two growth rates. Per the article:
My central finding is that the 30-year period prior to the pandemic was exceptional. During these years, both interest rates and corporate tax rates declined substantially. This had the mechanical effect of significantly boosting corporate profit growth. Specifically, I find that the reduction in interest and corporate tax rates was responsible for over 40 percent of the growth in real corporate profits from 1989 to 2019.
Corporate profits would have grown by 4.50%, not 7.76% annually, without the boost from interest rates and taxes, assuming his 40% contribution calculation is correct. Such would be on par
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