Falling Australian Profit Share Drags Market Lower

Australia’s corporate profit share has reverted to the upper end of a range which had prevailed for five decades prior to 2007 during which time it had been an especially compelling guidepost for medium term investors. The blue line in the chart showing private non-financial corporate operating surplus as a share of non-farm product is a macro indicator of business profit margins. The yellow line depicts the inflation adjusted All Ordinaries share price index. The resources sector profit collapse is the largest element in the overall profit share decline but approximately one-third of the fall comes from non-resources parts of the economy. The divergence between the two measures since 2008 reflects recovery from the 2008/09 share market collapse which, not having affected profitability immediately, warranted some adjustment. Unprecedentedly strong central bank liquidity flows may have also temporarily reduced market responsiveness to profit changes. With the prospect of the pre-2007 relationship being reinstated, a positive view of future market directions now appears to depend on a presently unlikely record-breaking non-resources profit rebuild.