Rhythmic Reasoning_Full Report_Final_EN - Flipbook - Page 10
THE DRUMMER'S EAR | RHYTHMIC REASONING
measured approach to portfolio construction, one that includes a
healthy blend of risk assets like equities and securities with capital
preservation qualities like fixed income, is prudent amid a number
of risks that investors should be cognizant of.
Fig. 3: S&P 500 leadership has broadened
relative to the last two calendar years
9.0%
Fig. 5: Economy-wide corporate profit
margins remain near all-time highs
9.8%
20%
7.5%
15.2%
13.5%
15%
6.2%
2023
2024
Mag 7
10%
2025 YTD
Rest of S&P 500
5%
Source: Bloomberg Finance LP, Scotia Wealth
Management | Contribution to S&P 500’s price return
0%
1947
This broadening can also be seen in profitability metrics with the
rest of the S&P 500's constituents starting to see net profit margins
move in the right direction, following in the footsteps of their Mag
7 counterparts (Fig. 4)
Fig. 4: Corporate profit margins are on the uptrend
28%
13%
Net profit margin
25%
12%
22%
11%
19%
10%
16%
9%
2021
2022
2023
Mag 7 - LHS
2024
2025
Rest of index - RHS
Source: Bloomberg Finance LP, Scotia Wealth Management
Of course, these margins could be pressured by tariffs that exert
upward pressure on input costs. As of now, we have yet to see the
tariff impact show up in consumer price data in a material way.
While certain tariff-sensitive items such as apparel and household
furnishings have seen some pickup, headline CPI inflation has not
moved substantially higher, indicating that companies may be
holding off on raising prices until they have more clarity on trade
policy. It remains to be seen how long businesses hold out, but it is
worth noting that economy-wide corporate profit margins are also
in a good place, sitting well above the historical average (Fig. 5). In
other words, businesses may have a bit of margin cushion to work
with, affording them time to gain clarity before raising selling prices
that could challenge their competitiveness.
On balance, we think the combination of these factors is
constructive for further corporate profit growth as recession risk
remains low and the tail risk of highly aggressive tariffs capable of
crippling global trade has receded. This is not to say that investors
should be taking on excessive risk in investment portfolios. A
1960
1973
Economy-wide profit margin
1986
1999
Historical avg.
2012
2025
Avg. (since 2000)
Source: FRED, Scotia Wealth Management
One of the risks is with respect to the labour market. While inflation
headwinds have yet to abate, recent soft payroll prints out of the
U.S. and negative revisions to past data were enough to prompt the
U.S. Federal Reserve to resume its policy easing cycle in September.
Beyond this meeting, it is unclear how quickly and forcefully the Fed
will cut rates. Much will depend on how labour market conditions
evolve and the extent to which tariffs raise costs for consumers and
businesses.
In the U.S., ongoing political interference into central bank matters
threatens to undermine the Fed’s independence which is crucial for
anchoring inflation expectations and maintaining financial market
stability. If the Fed appears to buckle under political pressure,
market-based inflation expectations will undoubtedly rise, raising
market volatility and weighing on the dollar’s standing. Investors
may start to lose confidence in the institutional credibility of the
U.S. economy and start to hedge against this risk by shifting capital
to other asset classes and markets.
Of course, corporate earnings will also remain top of mind. While
results through the year’s first two quarters have been good, there
appears to be little margin for error. For instance, in the latest
earnings season, companies that had reported misses on earnings
saw their stock price decline by 5.5% on average in the period
spanning two days pre-release through two days after reporting,
more than double the 5-year average of -2.4%. On the other hand,
companies that reported positive EPS surprises saw an average
price increase of only 0.4% through the same period, below the
5-year historical average of 1.0% (based on analysis conducted
by FactSet). In other words, anything short of perfection is being
punished by markets, suggesting much of the good news is already
priced in.
Concentration risk warrants consideration, too. While performance
in the U.S. has broadened out, it remains heavily reliant on a
small subset of companies. As of the end of June, the largest
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