You can sum up the difference between the US and UK stock markets over the last decade in two simple words: gross margins.
A company’s gross profit is what is left over after the cost of goods sold (including raw materials, energy and some wages) are subtracted. Take this as per cent of total revenue and that is the gross margin.
The S&P 500's average gross margin is around 33 per cent, while the FTSE 250’s is just 23 per cent. The US stock market gross margin is almost 50 per cent higher on average, which is indicative of its focus on technology rather than older industries. If a new person makes a Facebook account, the cost to Meta is minimal. Correspondingly, Meta's gross margin has been consistently above 80 per cent.
The more revealing thing is how consistently high margins are in America, particularly during the last two years of price rises. When inflation arrives, it increases the cost of sales. This was particularly the case in 2022 because a lot of the inflation was driven by energy prices which is usually a significant input cost. Correspondingly, the FTSE 250 margin dropped 6 percentage points to 19 per cent in the second half of the year, while in the US, it dropped less than 1 percentage point.
This consistency of the margin is indicative of the strength of the US economy. All companies want to increase prices when input costs rise but this is only possible if consumers can pay up, otherwise the company will lose customers. In the UK, companies felt they couldn’t increase prices easily because customers were feeling the pain of the cost of living crisis. When the economy stagnates, it becomes a zero-sum game. Either companies' margins' have to suffer or people will feel poorer. Eventually, they need to meet somewhere in the middle.
However, in a growing economy, companies can increase prices and improve margins, while at the same time consumers continue to feel wealthier. Last week, the US added 353,000 jobs in January almost double the 180,000 jobs that economists had been expecting. Meanwhile, real wages (which are adjusted for inflation) are up 0.8 per cent. So not only are companies' margins improving, but there are also more jobs which on average are paying higher wages.
This figure came off the back of the strong economic growth numbers announced last month. In the fourth quarter of last year, the US economy grew 3.3 per cent year-on-year. For comparison, in the same period, the UK economy has barely shown any growth at all.
A lot of ink has been spilt over why the UK has been stagnant for the past decade. Now, economists are shocked by America’s rapid growth. Donald Trump seems concerned about this surprise resurgence, having presumably hoped economic stagnation would play into his hands in the upcoming elections. He even tried to turn the narrative by claiming the S&P 500 hitting record highs was responding to the prospect of his presidency.
Identifying the exact reason for the US’s remarkable economic performance is tricky. It is ultimately the result of interactions between millions of people every day, and cultural forces are hard to explain and quantify. However, domestic energy security surely helps, especially when there is a war breaking out in the Middle East. In the last decade, US field crude oil production has doubled while it is up over 20 per cent in just the last three years.
Whether the US's relentless growth is good for its citizens can be debated. No one has ever taken capitalism this far. There is an opioid crisis, declining life expectancy and somebody just had a chip implanted in their head. However, this is an investment newsletter, and when an economy is growing margins can stay higher, workers feel richer and the stock market keeps going up.
