Falling Yen Bad News For US Profit MarginsNovember 21, 2013
With the Yen having fallen below 100, it is important to understand some of the consequences. Over the last 25 years, a structurally rising Yen has been good for US profit margins. In the chart below, one can see the 73% correlation over the last 25 years and how the sequence of higher highs on the Yen have been coincident to higher highs in profit margins.
If the structural Yen strength is giving way to structural Yen weakness, one area to be concerned about is US corporate profit margins. Per the scatterplot below, there is not a single observation over the last 25 years where the Yen was below 100 and profit margins were above 9%.
While there are many variables that impact profit margins, if we isolate on the Yen and run a regression against US profit margins, the model suggests a worrying outcome. It predicts profit margins of 7.8% in a year, down from 10% today. Importantly, that modeled drop in margins implies a 20% drop in earnings. We aren’t necessarily forecasting a 20% drop in earnings….but it is important to understand that, in general, a falling Yen is bad news for US profit margins.