Citigroup: The long-term fundamentals of the US stock market are solid, with productivity improvements being the main driver of rising profit margins

According to the Zhitong Finance APP, Citigroup recently released a U.S. stock strategy report. Citigroup believes that the increase in profit margins supports the rise in U.S. stock valuation multiples. Although the drivers of profit margins vary across different industries and individual stocks, overall, since the financial crisis, more than half of the improvement in the EBITDA margin of S&P 500 constituent companies can be attributed to increased labor productivity.

Citigroup pointed out that research shows a similar correlation between real GDP and non-farm labor productivity with changes in the EBITDA margin of the S&P 500 index. However, compared to GDP, the leading relationship between productivity growth and profit margins seems to be greater and better explains the significant changes in profit margins since the 2008 financial crisis. The bank added that the trajectory of economic fundamentals has a direct impact on profit margins, while productivity plays a more lagged role.

Specifically, Citigroup stated that since the 2008 financial crisis, the EBITDA margin of the S&P 500 index has shown an upward trend. Technological innovation and integration, the shift to a light-asset model, and the increase in the proportion of service-oriented enterprises have all positively impacted profit margins. These factors have also driven a structural rise in U.S. labor productivity, creating a divergence from developed economies such as Germany and France.

In the study, Citigroup established a linear regression model between the EBITDA margin and non-farm labor productivity, from which it derived the estimated profitability of the S&P 500 index. The results indicate that since the financial crisis, non-farm labor productivity can explain about 55% of the improvement trend in the EBITDA margin of the S&P 500.

Additionally, Citigroup noted that the unexplained EBITDA margin is closely related to three categories of factors: inflation, capacity and capital, and output. Among these, the difference in inflation (for example, the difference between product pricing and input cost inflation) is more important than any single inflation indicator. Capacity utilization and capital expenditure can enhance non-labor productivity. Finally, output indicators such as real GDP and industrial output are also crucial for economies of scale.

Citigroup stated that factors such as inflation, capacity, capital expenditure, and output, along with the structural trends in U.S. labor productivity, jointly determine the profit margin performance of the S&P 500 index. In the short term, the stabilization of productivity growth post-pandemic may help maintain profit margins at high levels, but the expansion momentum is slowing. If consumer spending weakens or tariffs raise input costs, inflation may become a negative factor. There remains uncertainty regarding output trends. However, the bottoming out of capacity utilization and the rising willingness for capital expenditure may provide some support.

Overall, Citigroup stated that it remains optimistic about the long-term fundamentals of the S&P 500 index and believes that the continuous improvement in labor productivity will support profit margins. However, challenges still need to be overcome by 2025, such as direct impacts from tariffs or indirect effects of policy uncertainty on consumer and business confidence. This is also reflected in the bank's downward revision of its full-year earnings per share (EPS) forecast for the S&P 500 index, and it expects the market to make further adjustments to consensus expectations