How Long Will High Profit Margins Last?

Our managers outperform our politicians. This isn't just an opinion but a fact—at least when it comes to growth rates.

• The growth rates of countries in the West - Germany 0.1 and America 2.5 - fluctuate between "embarrassing" (according to Christian Lindner) and solid. The heads of government and their cabinets are responsible for this.

• The ultimate measure of economic success for companies is profit growth. In this elite discipline, many managers, even in shrinking economies, deliver results that can only be described as impressive.

In Germany, the most profitable company last year was Volkswagen AG, which reported an operating profit of €22.6 billion (a two percent increase from the previous year). Deutsche Telekom was close behind, with an operating profit of €20.8 billion (up 35 percent). In Munich, BMW celebrated a 32 percent increase in operating profit, bringing it to €18.5 billion. The automotive manufacturing sector, Bavaria's most crucial industry, saw its operating margin increase by 1.2 percentage points to 9.8 percent.

Consequently, the dividends for the DAX (Germany's stock market index), set to be distributed in 2023, grew by 2.4 percent to a record €53.8 billion.

The CEOs of Siemens, Airbus and other German companies don't need to thank Olaf Scholz. If these CEOs were to express gratitude, it would most appropriately be directed at the central banks, which have supplied them with cheap money for years. Prof. Dr. Gunther Schnabl from the Flossbach von Storch Research Institute tells The Pioneer:

Nevertheless, there are still significant differences within industries. According to a study by EY, the traditional German auto manufacturer Mercedes-Benz is the world's most profitable car company, with a margin of 12.8 percent. Tesla's margin significantly fell last year from 16.8 to 9.2 percent due to discounts—and its stock price dropped accordingly.

However, the primary drivers of high profit margins are not central banks but the innovations that captivate the public and overshadow competitors. The Nasdaq, the technology-heavy stock exchange, currently has an average profit margin of 31.3 percent, which in turn boosts stock prices.

A company like Apple, according to market research institute Forrester, earns a margin of about 36 percent on products like the iPhone. At the same time, online services such as Apple TV, Apple Music and others bring in about 71 percent. The chip designer Nvidia enjoys an overall net margin of almost 56 percent.

Given these numbers and the ongoing record-setting performances at tech stock exchanges, the urgent question arises: How long can this last? When will profit margins—and thus stock prices—begin to shrink?

Karen Ward, Chief Market Strategist for Europe and the Middle East at JP Morgan Asset Management, provides a clear answer:

There are four reasons to believe she might be right about profit margins taking a hit:

1. Wages Put Pressure on Profits

As long as demand exceeds supply, profit margins will rise. This was particularly evident after the pandemic. Prices rose. And, suddenly, we had inflation.

A so-called second-round effect is now setting in. This is because the higher prices are reflected in employees' wage demands. As a result, union wage policymakers are trying to outbid price increases. Companies' scope for price increases is limited by wage policy.

2. Monetary Policy Limits Growth

This wage-price spiral has alarmed central banks around the world. The Federal Reserve in Washington has significantly increased borrowing costs with a total of eleven interest rate hikes in 24 months. The European Central Bank has followed suit.

Companies must now sacrifice margins if they want to invest. The era of risk-free interest rates is over.

The reason corporate profit margins continue to be exceptionally high is likely attributed to governmental initiatives such as the Green Deal in Europe and the Inflation Reduction Act in the USA, which mitigate the suppressive impact of central bank policies.

In the USA, Joe Biden has increased government spending to such an extent that he had to raise more than a trillion dollars in interest payments in 2023. In Europe, countries such as Italy and France have also gone deep into debt.

Therefore, the dampening effect of interest rate policy on profits will not be absent, but it is delayed. Companies love the government's deficit spending.

3. Shortage of Skilled Workers Threatens Profit Growth

The baby boomers are retiring, and there is a need for more skilled workers everywhere. This poses a challenge to maintaining high profit margins. Prof. Thomas Mayer, head of the Research Institute of the asset manager Flossbach von Storch, says:

The question of whether immigration can alleviate labor market pressures is a complex one. In the immigrant-friendly USA, this approach may be more effective than in Germany, where immigration into the social welfare system is more significant than into the labor market.

4. Profit Boost Through AI?

Can new technologies like Artificial Intelligence help increase profit margins? Laurent Denise from Oddo BHF believes:

The adoption of AI in companies is still not very advanced. According to recent figures from Goldman Sachs, only four percent of all US firms use generative AI.

Prof. Gunther Schnabl is also skeptical about margin expansions through AI. He notes:

Conclusion: High interest rates, significant wage increases and a labor shortage will likely lead to a decline in profit margins. Prof. Dr. Thomas Mayer from Germany's largest asset manager told The Pioneer:

In this turbulent environment, managers must now demonstrate their true capabilities. It’s time for a pioneering spirit in products, services and corporate structures. Or, to quote Steve Jobs:

• Peace talks? Foreign minister Baerbock travels to Riyadh in Saudi Arabia.

• Bad surprise: Yesterday, the stock price of Deutsche Bank plummeted by more than eight percent.

• German Labor Day: A German holiday commemorating American virtue

From April 2018 to August 2022, Herbert Diess served as the CEO of Volkswagen AG, leading the company in Wolfsburg into the era of electromobility.

However, his assertive approach, especially towards unions, ultimately cost him the trust of the Works Council, IG Metall, the SPD and the Porsche/Piëch owner family. Herbert Diess, whom we portrayed as the Che Guevara among CEOs, lost his job but not the respect of automotive experts.

Diess is now the chairman of the supervisory board at semiconductor manufacturer Infineon.

Last week he visited us aboard the Pioneer One. He remains a strong advocate of electromobility but now views the pace of the transportation transition more critically.

He thinks the 2035 combustion engine ban will likely be overturned, even though he initially welcomed it:

Diess is clear that the switch to electromobility cannot be made as quickly as the transition from landline to mobile phones. But globally, things aren’t looking too bad:

In Germany, there is a need to hurry with market penetration. He dislikes the politicians' hesitancy:

He holds the politicians responsible for not acting decisively and unsettling customers and the industry. However, Diess is not really surprised by this:

Still, the transportation transition cannot be achieved without political support:

You can listen to the entire conversation in German here.

The oil company and gas station operator Jet is planning to sell its entire network of gas stations in Germany. This was revealed in the quarterly report of the American parent company Phillips 66, which Pioneer correspondent Claudia Scholz examined in detail. The company writes that it is pushing forward with the sale of its retail distribution in Germany and Austria, including the Jet brand gas stations.

The 815 Jet gas stations in the country no longer fit into the long-term strategy. The trend continues: In January, competitor Total Energies sold its entire network of gas stations in Germany.

The trial commences: Yesterday, amidst tight security, the trial of nine defendants from the alleged terrorist group associated with Prince Reuss began at the Stuttgart Higher Regional Court - one of the most significant anti-terrorism trials Germany has seen to date.

The charges: The prosecution accuses them of being members of a terrorist organization that planned a nationwide violent overthrow, including an attempt to infiltrate the Bundestag with weapons. The nine defendants are considered the main ringleaders of the alleged terrorist group – the so-called "military wing."

In the latest episode of our Pioneer Podcast, you can learn more about the trial, the background of the Reichsbürger movement and what they are demanding.

Peace negotiations? Yesterday, Foreign Minister Baerbock traveled to Riyadh, the capital of Saudi Arabia. Alongside her counterpart, Antony Blinken, she participated in negotiations for a ceasefire in the Gaza Strip and the release of hostages held by Hamas.

Baerbock conducted bilateral talks with the Foreign Minister of the United Arab Emirates and met with the UN Coordinator for Humanitarian Aid in Gaza, Sigrid Kaag.

At the heart of the negotiations is an offer from Israel to Hamas. It proposes the release of about 30 of the 133 hostages who have been held in the Gaza Strip for more than 200 days. In return, Israel must release Palestinian prisoners from Israeli prisons and cease hostilities for a certain period. Additionally, Israel would refrain from conducting further offensives in Rafah.

Unpleasant Surprise: Deutsche Bank's stock plunged more than eight percent yesterday, now trading at €15.10.

Prompting the bank to announce after the close of trading last Friday, that due to legal risks associated with the acquisition of Postbank in 2009, provisions of €1.3 billion need to be made.

Potential Additional Demands: The Higher Regional Court of Cologne hinted on Friday that the takeover price paid to Postbank shareholders in 2010 might have been too low. Deutsche Bank "continues to disagree with such an assessment strongly."

Timing: The needed provision announced on Friday nearly matches Deutsche Bank's net profit for the first quarter, which was declared the day before. On Sunday, the bank issued an Investor FAQ stating that there was "no indication beforehand that the hearing would influence the management's assessment of the likelihood of future capital outflow."

J.P. Morgan noted in an analysis that the legal dispute did not change Deutsche Bank's "long-term investment background" but lowered its price target from €18.20 to €17.70. Berenberg stated that the provision could "torpedo the distribution plans." Deutsche Bank noted that it is "too early" to determine if the planned share buyback program for this year will be impacted.

A German holiday that commemorates American virtue:

Tomorrow, on what we call 'Tag der Arbeit,' the German workforce rests. Offices, factories, and workshops will be closed. Unions will hold their traditional rallies.

German labor organizations and the Social Democratic Party (SPD) traditionally take immense pride in the history of this national holiday, standing in solidarity with workers around the world. The 'Tag der Arbeit' is not just a national holiday, but a global symbol and reminder of the ongoing international labor rights struggle.

This holiday was inspired by the hard-won historical victory of American workers nearly 140 years ago:

In May 1886, close to 400,000 US workers called for an 8-hour workday in the largest national strike the country had witnessed at that point. Many US protesters paid with their lives for what most Western countries consider standard today. Three years after the bloody riots of Chicago, in 1889, the International Workers Congress in Paris paid tribute to their American comrades, declaring May 1st International Labor Day and calling for annual workers' rights marches to commemorate the day.

In keeping with this spirit, we will celebrate 'Tag der Arbeit' by putting our pens down. We will be back with another briefing on Thursday.

Wishing you a wonderful start to your day. Stay informed. Stay with me.

Best wishes,