Gina Martin Adams, Columnist

When Will Stocks Drop? Watch Profit Margins (and Get Nervous)

The evidence is mounting that companies are having a harder time passing off cost increases to their customers.

August 2, 2021 at 10:00 AM UTC

Gina Martin Adams is the global head of portfolio strategy and chief equity strategist for Bloomberg Intelligence. Prior to joining Bloomberg, she was the head of U.S. equity strategy for Wells Fargo Securities.

It’s time for investors to pay attention to profit margins.
Photographer: Michael Nagle/Bloomberg via Getty Images

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Want to know where the S&P 500 Index may be headed after reaching another record high? Take a look at profit margins.

Operating margin forecasts are a strong leading indicator of stock prices. A decline in such outlooks preceded routs in the S&P 500 in 2011, 2015, 2018 and 2020. What’s concerning now is that analysts have stopped raising their forecasts, and if they begin to lower them, it's likely to lead to a dip in the broader market again. And it’s not like there’s a lot of room for further improvement in margins, defined as earnings before interest and taxes divided by sales. The consensus among analysts is that they will expand to 16.7% over the next 12 months, topping the previous record of 16.4% set in 2018.