Profit margins are unlikely to continue in margins as a slower pace in the trend of powering U.S. earnings globalization is partially offset by higher 12 In addition to stretched valuations, the risks productivity because of idea sharing. posed to earnings by high inflation and the growing likelihood of recession underscore our We expect U.S. earnings growth to average cautious stance on U.S. equities. Our framework 5% per year over the next decade, which is below for assessing U.S. earnings growth breaks it the 6.4% that investors experienced over the last down into revenue growth and profit margins. decade. Although this information is useful in We find that revenue growth is a function of informing our forecast, long-term investors must global GDP growth and that profit margins are remember that what matters most for equity determined by global trade intensity and labor returns is the price paid for earnings, not the costs. Figure II-11 shows our model for U.S. profit earnings themselves. Our research finds that margins compared with actuals. Profit margins GDP growth explains some of revenue growth, are currently at a cyclical high, and we expect which in addition to profit margins explains them to decline toward our estimates in the earnings growth. But earnings growth explains coming years, mostly because of higher labor only about 15% of the variation in equity returns; costs. Longer term, we expect a modest decline valuations matter more. FIGURE II-11 U.S. profit margins may face cyclical pressure in the near term, but should remain above long-term averages % Cyclical pressures s  n gi r a Longer-term m  trend fit o r otal profit p . margins S .  U Fair alue Fair-alue  range         Notes: Profit margins are broken into their cyclical and trend components and forecasted using an Ordinary Least Squares (OLS) regression model with trade intensity (sum of imports and exports) and labor costs as the independent variables. We expect higher productivity to drive higher profit margins given the linear relationship between productivity and profit margins and our view for higher productivity based on our proprietary Idea Multiplier. For more information on the Idea Multiplier, see The Idea Multiplier: An Acceleration in Innovation Is Coming (Davis et al., 2019). Sources: Vanguard calculations, based on data from Refinitiv, as of June 30, 2022. 12 For more information on Vanguard’s view on these two “megatrends,” see Lemco et al., 2021, and Davis et al., 2019. 48