Corporate profits soar amid weak job growth
WASHINGTON — Look at the economy and you'll notice an unusual disconnect.
The economy is being slowed by a tight job market, scant pay raises and weak business investment. Yet corporate profits are reaching record highs and fueling record stock prices.
How are companies managing to earn so much money in a sluggish economy? And why aren't their profits goosing the economy?
For starters, weak job growth has held down pay. And since the recession struck six years ago, businesses have been relentless in cutting costs. They've also stockpiled cash rather than build new products or lines of business. And they've been earning larger chunks of their profits overseas.
All of which is a recipe for solid profits and tepid economic growth. The economy grew at a meager annual rate of just 1.8 percent in the first half of 2013. The unemployment rate is 7.2 percent, far above the 5 to 6 percent considered healthy.
Even so, corporate profits equaled 12.5 percent of the economy in the April-June quarter, just below a 60-year high reached two years ago. Profits of companies in the Standard & Poor's 500 have nearly doubled since June 2009. Earnings appear to have risen again in the July-September quarter.
Big companies like Kellogg, FedEx and Best Buy have been slashing costs in the face of slowing revenue. Their strategy has been working: Despite sluggish revenue, their profits are up.
Burger King's sales dropped last quarter as competition intensified. Yet the company's earnings surged because it cut expenses and enjoyed growth overseas.
“Corporations have more market power than workers have and have kept wage growth to subdued levels,” said Dean Maki, an economist at Barclays. “That's left more for corporate profits.”
Those solid earnings have helped boost stock prices. So has the Federal Reserve's drive to keep long-term interest rates near record lows: Lower bond yields have led many investors to shift money out of bonds and into stocks, thereby boosting stock prices.
The Dow Jones industrial average has jumped nearly 20 percent this year, closing at 15,639 on Monday, just below its record high.
Economists cite these factors for the gap between healthy corporate profits and subpar economic growth:
Wages and salaries equaled just 42.6 percent of the economy in the April-June quarter, near a record low set in 2011.
More than 8.5 million jobs were lost in the recession and its aftermath, leaving leaner, more productive workforces. Corporate revenue rose as the economy recovered.
But workers have not benefited much. With unemployment still high, they've had little leverage to demand higher pay. Many have been happy just to have a job.
“We've just had a very lopsided economic recovery,” said Ethan Harris, an economist at Bank of America Merrill Lynch.
Smaller paychecks have deprived Americans of money to spend. In the 30 years before the recession, consumer spending grew an average of 3.4 percent a year. Since 2010, just after the recovery began, it's risen just 2.2 percent a year.
The stock market's gains have boosted total household wealth. But they have not enriched most Americans. The wealthiest 10 percent of households own about 80 percent of stocks.
This week Kellogg said it would cut about 7 percent of its workforce — 2,200 jobs — by 2017. The cuts are part of a “global efficiency and effectiveness program,” the company said.
Even though Kellogg's sales were flat in the July-September quarter compared with a year earlier, it squeezed out 2.5 percent more net income. A key factor: It cut administrative and borrowing costs. Its shares have risen 15 percent in the past year.
The average sales growth of an S&P 500 company was 2.35 percent in the first six months of 2013, down from 3.76 percent in 2012, according to S&P Capital IQ. The average profit margin for an S&P 500 company widened from 8.1 to 9.1 percent in the same period.
Higher profits could help the economy if corporations plowed them back into new plants, equipment and other projects. That has not happened.
“Corporations have been extremely cautious in their spending in this recovery,” said Maki of Barclays.
Business spending on big-ticket items like computers, industrial machinery and capital goods has remained about one-third below the average in previous recoveries, Harris estimates.
Instead, companies have stockpiled a record $1.8 trillion in cash, according to the Fed, up nearly 10 percent since the recession ended in 2009. And thanks to the Fed's drive to keep rates low, big companies have been able to borrow cheaply and replace higher-cost debt.
All that has bolstered corporate finances and helped boost stock prices, even though companies remain reluctant to expand.
Improved finances are “great for the company and its stock price, but from the point of view of the broader economy, you'd prefer they use the money to hire more workers and invest in more projects,” Harris said.