The chart below may, at first sight, look a little complicated but all it shows is Europe’s profit cycles of the last 40 years. Analysts from UBS have rebased at zero real earnings per share for each of the four completed cycles – starting just after the previous cycle troughed and continuing upwards and then down again as it heads to its own low – as well as the current cycle, which began in 2010.
This chart is useful as it provides some historical context for a series of events investors are more used to living quarter by quarter or year by year. The reality, however, is that profit cycles last a lot longer than that and indeed, as the chart shows, over the last four decades no profit cycle has lasted less than six and a half years.
So we are almost three years into the current cycle and, yes, profits do appear to be weakening. However, the interesting thing about the four completed cycles is that while they are all different, there is a familiar look to them too. To a greater or lesser extent, they all track up from the bottom left corner of the chart towards the top right before dropping back down again – as cycles do.
Many investors seem more interested in short-term movements than longer-term trends yet surely you can have more confidence when trying to predict the latter. Every cycle in this chart may be different yet, as Mark Twain is supposed to have said, while history may not repeat itself, it does rhyme. The opening phase of the current cycle does not look much like 2003/09 but it does bear more than a passing resemblance to 1973/81.
Certainly there are reasons to believe profits might come under pressure in the short term but profits are made up of very many different parts of the economy. Some of these are already very low and therefore have the opportunity to go up while some are very high and, frankly, look like they will come down over time.
Ultimately, there is nothing about the current cycle that would appear to be completely out of kilter with anything we have seen before. That is not to say profits will not drop further down over the next year or that this cycle will not end up looking slightly different from – or even worse than – 1973/81 but it does seem a bit churlish to ignore this chart completely.
When looking at businesses, we genuinely take a five-year investment view and part of our reason for doing so is we would rather call the longer-term trends than any short-term swing. There are businesses we own – for example, high street retailers, UK construction and house-building – where profits are pretty poor but have seen some improvement and we do not believe the cycle has ended just yet. History looks to be rhyming once again – and certainly sounding more in-tune than the ‘this-time-it’s-different’ crowd.