US earnings season is in full swing for the first quarter of the year, and the results seem to confirm a slow patch, at the very least, or a decay in the robustness of the business cycle at worst. The rise in first-quarter earnings has been weak. And, if we remove large US banks from the equation, we see a decelerating trend.
But what is interesting is that margins are about 100% higher than their 50-year average. The increase is the result of competitive unit labor costs, the lower cost of capital and greater asset turnover. If we look at how much and how efficiently Americans are working, we will get a better idea of how companies, but not labor markets, have been the beneficiaries of this business cycle.
Americans are working longer hours
The average work week is approaching recent cyclical peaks. This is an interesting US trend, particularly as other countries are debating the reduction of their work week. The phenomenon of working longer hours has had some important effects on the US economy. Similarly, the average number of hours worked per week has been declining for the past 60 years, up until this cycle. But now, companies are working very skilled workers longer hours and paying them a wage that does not keep pace with the nominal growth rate of the economy.
Americans are working more efficiently
When we measure output per hour, which is a measure of productivity, against compensation per hour, we see that the gap between the two has been widening over time, most significantly in this business cycle.
Companies, cautious and tentative while remembering the trauma of the last recession four years ago, have been reluctant to hire new employees. They have found that with high unemployment, existing workers are willing to work longer hours to pay the bills. Better yet, these workers that have been in the work force have updated skills and are not asking for raises. The result of this trend is that US unit labor costs have become very competitive compared with other developed countries. In other words, more goods and services are being produced in the United States per hour worked than in most comparable countries.
The results of this change
- The American worker is ranked very high in the world for productivity.
- Productivity leads to better profit margins.
- These profit margins fuel cash-flow growth and allow companies to strengthen their balance sheets.
- This trend balances off inflation risks because greater productivity offsets inflationary forces; inflation remains in check despite US growth.
- Exports and manufacturing boost growth and offset local and state job cutbacks.
What is next? The idea of the American work force working longer and more productive hours has its limits. New jobs will have to come along because our companies may be getting close to a tipping point in terms of getting more productivity out of exhausted workers. New job growth, if it does accelerate from current trends, would be good for GDP and help sustain the consumption growth we have already seen in this cycle.
If hiring picks up, less productive workers might be hired as well as those who have been out of work for long periods. In such a case, productivity could fall and profit margins could come under pressure.
If that happens, US companies will have a sort of grace period. Right now, as they bask in a period of high profits and record margins and cash flows, they are able to convince investors to overlook the disappointing revenues that have resulted from weak sales. Any grace period would likely last a year or so, until the cycle changes.
We are going to be hearing a lot more about disappointing corporate results. I’m not sure how long we can go on like this unless we get some top-line growth from Europe and emerging market countries. And thus, far data coming out of those regions have been relatively weak.
With central banks around the world working toward the same end to create inflation and jobs, the likely outcome will be a mild recovery in Europe in late 2013, faster growth in the key emerging countries and continued real growth of about 2% in the United States.
No forecasts can be guaranteed.
The views expressed are those of James Swanson and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation or solicitation or as investment advice from the Advisor.