Need for greed: equity drift

Everybody’s talking about greedflation. Here’s Alphaville, and Alphaville again. Here’s Unhedged, again and again and again. Even mainFT is getting in on the action.

Tl;dr the argument is that US profit margins are at half-century highs because companies have been using the inflation crisis as cover to take the piss with price hikes.

We know what you’re thinking: “the FT employs too many people” “I’m about to be lectured again about that UMass Amherst paper”. Dear reader, fear not: we’re here to defend greedflation. Kinda.

See, one of the other recent dynamics that’s been rending of garments and gnashing of teeth in the finance community is why equity volatility is so low despite several recent bank collapses and some recession-y vibes coming off the global economy.

Here’s the VIX as of Friday:

Callie Cox from eToro articulated one of the most intuitive arguments as to why this is happening in an FT Alphaville piece last month — that the VIX isn’t reflect the dramatically increased usage of short-dated options:

Think about it: the Vix is a measure of demand for S&P 500 options expiring 30 days into the future. By nature, it wouldn’t pick up the demand for daily and weekly options, a significant chunk of its total volume. No wonder the Vix was the least sensitive to market swings in a decade last year.

Cboe Global Markets is certainly alert to this issue, which is why a new 1-day VIX is launching today.

But what if the reason was simpler — and came from the top down, rather than the bottom up?

That’s the hypothesis of Société Générale’s Dérívátívés Réséárch team, who say that greedflationary margin-padding “provides a compelling explanation for the robustness seen in this part of the economy, and also for the subdued volatility in equities”.

Jitesh Kumar and Vincent Cassot write:

Profit margins for corporations are cyclical — they rise going into a recovery, peak around the middle of the cycle and then fall sharply going into recession. Using the recession forecast for the US in 2024, we find that profit margins are running above long-term historical averages. From this vantage point, the subdued level of equity volatility should not seem surprising.

Indeed, they argue that margins are so padded that even mentioning the word recession might be premature:

While US earnings estimate revisions have indeed been negative for a few months now, the levels are consistent with the “medium vol” regimes from 2002 and 2015. Earnings need to drop significantly more to reach levels seen during economy-wide recessions.

Even more striking is the divergence between the US and Europe — where the spread on earnings revisions is now the widest on record:

This can’t go on forever, SocGen analysts concede: transmission of significantly US monetary tighter policy is yet to kick in, and the availability of credit is tightening.

But might we some day look back at events of the past few months, and wonder whether regressively-bloated margins provided some helpful padding during the banking crisis of March ’23?

Maybe, but we can be sure nobody will like you for saying it.