MW S&P 500 record profits are a double-edged sword - and it could slash your returns
By Mark Hulbert
With profit margins now twice their historical average, big U.S. stocks are priced for perfection
One market indicator predicts a 10-year inflation-adjusted return for the S&P 500 of just 1.8% annualized.
The S&P 500 would shed half its value if record-high corporate profit margins were to revert to their historical mean.
Based on the nearly completed earnings season, the S&P 500's SPX net profit margin for the first quarter was 13.4%, according to FactSet. As you can see from the chart below, that's more than double the index's 6.3% average since 1946 (according to the Don't Quit Your Day Job website).
To appreciate the stock market's vulnerability to the profit margin reverting to its long-term average, consider that a stock's price represents the outcome of a three-part formula: (Total revenue) x (Profit Margin) x (P/E Multiple).
Everything else being constant, a lower profit margin translates into a correspondingly lower price.
This formula spells trouble for the U.S. stock market even if profit margins stay where they are. In that case, the above formula translates into a projected 10-year inflation-adjusted return for the S&P 500 of just 1.8% annualized.
That's on the assumption that corporate revenue grows at the same rate as gross domestic product. The Congressional Budget Office is projecting that U.S. GDP in inflation-adjusted terms will grow at a 1.8% annualized pace between now and 2036.
Since the S&P 500's price-to-earnings ratio currently is near the high end of its historical range, it's optimistic to assume it won't fall back. But assuming that it stays constant along with the profit margin, the S&P 500 in real terms will grow at the same pace as revenue growth.
Will profit margins revert?
The key question is whether profit margins will revert towards their historical mean. Wall Street's graveyards are filled with analysts who have insisted that they would. Except for temporary declines during the global financial crisis and the COVID-19-induced recession, the S&P 500's profit margin has been trending ever higher.
In fact, FactSet is reporting that the analyst consensus estimate is for the profit margin to keep rising - reaching 14.6% by the fourth quarter of this year.
Robert Arnott, founder of Research Affiliates, nevertheless believes that "corporate profit margins are more likely to fall than keep rising." That's for two reasons, he said in an interview. The first is that mean reversion is a natural process in a competitive economy: High profit margins attract competitors, and the resultant competition ultimately will cause those margins to decline.
The second reason is sociopolitical, according to Arnott: When more of a corporation's income goes to profits, less goes to labor - and that, in turn, "can lead to a populist backlash." That is not an environment in which the economy is likely to thrive.
The possibility of a populist backlash is especially relevant currently, given that the share of national income going to labor is now at an all-time low. Over the four-decade period plotted in the chart above, that share has fallen to 51.8% from from 57%.
The bottom line? A continuation of the bull market is dependent on ever-expanding profit margins. How confident are you about that?
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.
More: Stocks are losing their edge over bonds, in an ominous sign for the market
Also read: Stuck in 'survival spending'? 5 ways to build wealth even when the odds seem stacked against you.
-Mark Hulbert
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May 06, 2026 12:49 ET (16:49 GMT)
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