Sliding Corporate Profits Are a Darkening Cloud for U.S. Workers
(Bloomberg) -- Corporate profitability is casting a shadow on the brightest aspect of the U.S. economy -- the labor market.
Profits have fallen for five straight quarters, the longest skid since the last recession, according to the Bureau of Economic Analysis. While early results from the current earnings season indicate the string could be snapped, Corporate America is facing an uphill battle to make money and may soon become more aggressive in its cost-cutting amid sluggish demand and scant pricing power.
“We’re hardly out of the woods on the profits recession,” said Joseph LaVorgna, New York-based chief U.S. economist at Deutsche Bank Securities Inc. “Payrolls will downshift this year and continue to slow in 2017. Companies are going to have to employ fewer workers and eventually start to lay them off so as to defend very weak profit margins.”
Profits have been a pretty accurate bellwether of the economy. Only once in the post-World War II era -- in the 1980s -- have earnings slid at least five consecutive quarters without coinciding with a recession.
In the July-to-September period, earnings at Union Pacific Corp. sank as the railroad struggled to boost prices. Delta Air Lines Inc. said it will limit plans to expand seats and flights to bolster fares, and computer maker HP Inc. will cut as many as 4,000 jobs over the next three years. The Federal Reserve’s latest Beige Book business survey showed some restaurants are shelving expansion plans as wage growth erodes already tight margins.
Up to this point, businesses have slashed inventories and curbed investment, helping explain why economic growth in the first half of the year was so anemic. Without a more dramatic pickup in U.S. and overseas demand to help turn around balance sheets, firms may next resort to less hiring and get stingy on wages just as workers are finally seeing pay move higher.
“It’s coming,” said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York. “The pressure on margins is going to intensify as we go through next year. It’ll result in increasingly aggressive cost-cutting, which means much slower job growth, which will then weigh on consumer spending and the overall economy.”
He projects the economy will grow an average 1.2 percent in the first half of 2017 before reversing and shrinking 0.5 percent in the final six months.
While the plight of the energy industry has been a big driver, the weakness in profits extends beyond America’s oil fields, LaVorgna said. Year-over-year earnings excluding energy have also shrunk for five consecutive quarters.
Not everyone is convinced the outlook is deteriorating.
“The job market seems to be fairly immune to a lot of things that have been thrown at it,” said Ryan Sweet, senior economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. His analysis shows that while profits matter for job growth, the correlation has weakened considerably in this expansion.
Fed Vice Chairman Stanley Fischer said this week that profits are declining from historically high levels, which “at some point was bound to happen.”
Better-than-forecast results at banks have also added to early signs this earnings season that Standard & Poor’s 500 Index members may well break their five-quarter streak of profit declines.
Neil Dutta, head of U.S. economics at Renaissance Macro Research LLC, sees several reasons to be optimistic, including slightly better global growth, a fading drag from the strong dollar, commodity-price stabilization and rising core inflation.
“The drivers of the decline in profitability have ebbed,” Dutta said. “There’s a bit more pricing power for companies now, and that’s bullish for corporate profits. It could well be that a lot of firms are seeing the decline in profits as temporary, which is why they’re sticking to their hiring plans.”
Monthly payrolls will climb at an average 150,000 pace in 2017 after about 165,000 this year, and “financial conditions are now easing, so there’s room for business investment to pick up,” Dutta said. In short, “most companies are looking through the decline in profits and will continue to do so.”
Payroll growth, which softened the past two months, has downshifted from last year’s 229,000 average. Economists project more measured gains the rest of this year, attributing it to a shortage of qualified workers as the labor market tightens. That’s one reason why wage pressures are building.
The Beige Book showed businesses in Fed districts including Philadelphia, St. Louis, San Francisco, New York and Boston cited employee compensation pressures.
That trend could be short-lived, especially as corporate productivity continues to languish. As workers take home more pay, companies will look for more ways to alleviate the squeeze on margins. Any belt-tightening would be bad news for household spending, the main source of economic growth this year. A slowing U.S. expansion will tie the Fed’s hands after they probably raise interest rates in December, MFR’s Shapiro said. He expects policy makers will “have to unwind” their move next year.
“It really comes down to the corporate sector, and we expect things will be significantly weaker,” Shapiro said. “The consumer will still be driving the economy, just going the wrong way.”