Submitted by Mark Hanna
Courtesy of MarketMontage. View original post here.
Here is some detail from Gary Shilling’s thoughts on the labor market and how it relates to his recession 2012 call. Keep in mind, labor is a lagging or at best coincident indicator … not a leading one. Hence the ‘better data’ of late does not have much bearing on what is coming down the road. That said weekly claims are at 4 year lows, which is a positive. And, a point I’ve made many times over the past few years is important to remember – more labor = higher costs. So more hiring is not necessarily good for companies (or their profits) even if it is better for the economy. At least in the short(er) run.
If you missed part 1 yesterday go here.
- Employment in the U.S. has gained in recent months because businesses have, at least temporarily, run out of productivity enhancements that had allowed them to cover output gains with reduced staff. Payroll-employment growth has risen in recent months, though an unseasonably warm winter may have provided a temporary boost. (The disappointing report for March, released last week, may be a case in point.)
- The drop in initial claims for unemployment benefits reflects the decline in layoffs, but that’s not the same as new hires, which have risen much more slowly than job openings. These trends for the total job market apply to small businesses, which account for about half of new employment.
- Job openings: The U.S. has a lot of job openings, but having endured huge layoffs in recent years, employers are being very picky in new hiring. Contrary to Federal Reserve Board Chairman Ben S. Bernanke’s assertion that high unemployment is mainly a cyclical concern that will be solved by economic growth, I believe that a big part of the problem is structural. (agreed although my view lies more in globalization and labor wage arbitrage – along with technological innovation eradicating a lot of former “mid level” jobs. This pushes out most of the jobs remaining to the high end or low end) Employers may have jobs available for software engineers or skilled machinists, but unemployed residential-construction carpenters probably don’t have the necessary skills to find work. Employment for college graduates is up 5.8 percent so far in the recovery but jobs held by high school dropouts, generally with low skills, are down 3.9 percent.
- Another measure of the labor market is voluntary resignations. People tend to decide to leave a job when they believe better positions are abundant, a normal circumstance in a recovery. But the number of voluntary departures after the 2007-2009 recession showed only an anemic rebound from the earlier collapse, and is again turning downward in recent months.
- Business Cost-Cutting: During the sluggish business recovery that began in mid-2009, sales-volume increases for U.S. business have been tiny, and the ability to raise prices was very limited even as commodity and other input prices climbed until about a year ago. As a result, profit margins were threatened. Meanwhile, foreign competition has been fierce.
- … but the biggest concern of these business owners isn’t labor availability, access to loans, taxes, regulation or insurance — it’s weak sales. That means the route to higher profits has been cost- cutting and productivity enhancement. Labor costs are the largest expense for most companies, certainly the largest over which they have much control. The huge layoffs produced rapid productivity growth in 2009-2010. And since employment costs have been running at a steady and low annual rate of about 2 percent, the productivity gains flowed through to declining unit labor costs. As a result, sales-volume growth in 2009-2010 required few new employees or even reduced staff. (very important point)
- This cost-cutting has been so effective that, coupled with the revival of financial-sector earnings, corporate profits as a share of national income hit a record high in the fourth quarter of 2011. Not surprisingly, there is an inverse correlation between profits and labor compensation’s shares of national income. (in a globalized world in industries that compete across nations, those with the capital win – while labor loses. This is a stark contrast to say healthcare which is both federally subsidized and local – difficult to outsource your heart surgeon)
- Manufacturing productivity: Labor-intensive factories producing items such as textiles or shoes have long departed American shores for low-cost venues abroad and may never return. Those that remain — and the type of manufacturing that is coming back to the U.S. in the much ballyhooed “reshoring” — is robot-intensive, highly automated production that requires limited labor. Manufacturing output has recovered from its recessionary low, though not to the previous peak. Yet output per person, a measure of productivity, after the usual recessionary decline, has resumed its robust upward trend.
- This means the long-term decline in manufacturing employment has only been arrested, with no meaningful job gains. Indeed, after falling by 5.8 million from January 2000 to January 2010 and by 2.3 million from the start of the recession in December 2007, factory jobs have gained only 433,000. These trends will no doubt persist, with U.S. manufacturing growing, but without much benefit to labor. [Nov 29, 2010: America Has Less Manufacturing Jobs Today than Before World War 2]
- Jobs up, profits down: As in the past, the large share of national income accounted for by high corporate profits is unlikely to last for long. In a democracy, neither capital nor labor keeps the upper hand indefinitely. (This is debatable, as the U.S. has enjoyed a long period of “corporatracy” (sp?) – is this still democracy as we knew it? With the ability to move jobs offshore or even within states and a desperation for any job domestically, I think large corporations own most of the cards. And we have not even discussed their stranglehold over both parties via the lobbyist system. That said corporate profits are at a massive extreme relative to labor so perhaps “some” reversion to mean will occur – maybe.) In any event, unit labor costs are now rising. The growth rates of operating earnings of Standard & Poor’s 500 companies – – after a post-recession leap as financial institutions went from deep losses to renewed profits — are receding. Revenue growth may also be falling, starting with the decline in the fourth quarter of 2011.
- The recent drop-off in rapid productivity growth may be the key to the recent pickup in payroll employment. Rather than stretch existing employees over more units of production as sales increase, U.S. businesses may have been forced to hire more people in recent months.
Shilling has a very dour outlook on corporate earnings versus the view by the masses:
- In conjunction with a major recession in Europe, a hard landing in China and foreign-earnings translation losses caused by a rising dollar, the operating earnings of S&P 500 companies could drop to $80 per share this year, compared with Wall Street analysts’ expectations of $104.
- That would almost guarantee a major bear market with a likely price-earnings ratio low of about 10. This implies that the S&P 500 index (SPX) would be around 800, a 43 percent drop from its recent level.
We can take issue with the 10 multiple, but even slap a 13x on $80 and you have a far lower stock market. But again, that $80 is vastly lower than anything out there on the Street. I’d consider it more an issue for 2013 if the massive federal government assistance (i.1. 9-10% annual deficits) does not continue. Which I don’t see changing despite all the hot air coming out of D.C. about deficit reduction.
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