Will U.S. Avoid a Recession in 2012? (Part 2)
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.) Furthermore, this growth is benchmarked to an extremely low recessionary base, and the unemployment rate, while down from 9.1 percent in August, is still high, at 8.2 percent.
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 were up 16 percent in February compared with a year earlier, but in a survey by the National Federation of Independent Business, a net zero percent of small-business owners said they planned to hire over the next three months. Furthermore, would-be entrepreneurs aren’t all that enthusiastic: Only 2.7 percent of job seekers started new businesses in the last quarter, down from 12 percent in the third quarter of 2009.
-- 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.
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. And the skills of those out of work for extended periods, as is true of many people today, tend to erode. In February, 43 percent of the unemployed were jobless 27 weeks or more, and the average number of weeks a person was unemployed was 40.
Furthermore, homeowners whose mortgages exceed the value of their houses can’t easily sell their property if they take jobs in distant locations. And if both spouses work, one may be unwilling to accept a job in a faraway city for fear that the other can’t get a job there, too.
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.
Optimism among small businesses has recovered somewhat from its recessionary collapse, 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.
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.
-- 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.
-- 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. Quite apart from the Obama administration’s determined effort to redistribute income in favor of lower-income households, the seeds of narrower profit margins have already been sown. In recent quarters, productivity growth has been tiny. Have we reached bottom in terms of cost-cutting? Industrial leaders say productivity- enhancing opportunities are never exhausted, but it is possible that the low-hanging fruit has all been picked, at least for now.
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.
Meanwhile, fewer S&P 500 companies are beating analysts’ estimates. I’m suspicious of these numbers, in any case: Analysts tend to be optimistic in earnings estimates, partly because they want to curry favor with the companies they follow, and companies want to discourage high estimates so they can beat projections.
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.
-- Corporate earnings implications: More jobs are about the only spur to household incomes, and consumer spending is the only source of strength in the economy this year. If new employees spend their paychecks freely, they could create more consumer demand, additional corporate revenues and profits, more jobs, and so on, in a self-feeding cycle. But, as I discussed in Part 1, new and old employees are more likely to retrench and precipitate a recession.
That would cause great disappointment for corporate profits. 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.
In Part 3, I’ll examine why the Fed may embark on a third round of quantitative easing if the economy weakens this year and whether Congress will be tempted to enact policies of its own to address a huge fiscal drag in 2013 as payroll and income taxes rise and unemployment benefits plunge.
(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. Read Part 1, Part 3 and Part 4 of the series.)
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