By Eric Wahlgren
No doubt about it, investors like to see Corporate America squeezing the most it can out of its employees. As the economy has bounced back, productivity, or output per worker per hour, has continued to expand. Meanwhile, stock prices have risen 50% from their October, 2002, lows as a smaller, more productive workforce seems to have turbocharged corporate profits. While productivity grew 4.2% last year, profits jumped 18.2% -- the biggest increase since 1995. Gains garnered through investments in technology and outsourcing generally result in a stronger bottom line because they keep a lid on staffing costs -- typically a company's single biggest expense.
Investors also like to see a trend that generally lowers productivity growth. And that trend -- hiring -- has been maddeningly elusive in this economic recovery. "Labor is consumers, and you can't get top-line revenue growth if you don't have people spending money," says Sherry Cooper, global economic strategist at BMO Financial Group in Toronto.
A tension exists between job growth and productivity, she points out. As the U.S. economy continues to expand at an anual rate of about 4%, the friction is palpable in executive suites. On one side are the bean-counters, who want to push existing employees to do even more. On the other side are maxed-out managers, who want to add workers to the payroll.
With so much productivity growth over the last few years and no job growth, something has to give. And CEOs who want to see stock prices move higher in 2004 probably will start to listen to their stressed workers, say the pros. It will be job growth, not further productivity gains, that most likely boosts share prices for the rest of 2004.
"In the short run, productivity gains are fine, but for this expansion to be sustained, you need job growth," says Joel Naroff, president of Naroff Economic Advisors, a strategic economic consulting firm in Hollan, Pa. Naroff points out that the consumer-led expansion has been aided by mortgage refinancings and tax cuts from Washington, and that the effects of both are beginning to fade. "Job growth becomes the linchpin," he says. "If you don't have job growth, I think investors will start to question the strength of the expansion. And if consumer demand slows down, businesses are going to become cautious again."
Sooner or later, the jobless recovery could backfire: Without hiring, consumer confidence declines, people cut back on spending, businesses ring up fewer sales, and profits falls -- all of which ultimately leads to falling stock prices.
This may be just the time to start adding people, too. Businesses appear to have wrung about as much as they can out of employees. Productivity growth in the fourth quarter of 2003 declined to a 2.7% annual rate from 9.5% -- a 20-year high -- in the previous quarter. This sharp quarter-to-quarter slowdown suggests that companies have hit a wall. "I think we're at the limit of pumping up productivity without hiring new workers," Cooper says. "You are ending up with a lot burned-out people."
To meet increased demand, businesses will need more staff to make and sell products and services. "If we continue to see this strong gross domestic product growth, we will have to have some pickup in jobs," says Seth Scholar, senior research analyst at Sand Hill Advisors, a wealth-management firm in Palo Alto, Calif. But, he cautions, job growth this time around won't match that seen in the boom years.
Economists are mixed on what kind of job creation will be needed to keep stocks rolling. Economists are fiercely debating how many jobs were lost over the past three years -- with some estimates even claiming gains if you count part-time employment, vs. the 2 million jobs that the Labor Dept. says were shed.
A general consensus holds, however, that just to absorb all the people who want to work, employers would have to be adding a minimum of 150,000 jobs a month. January's payroll survey, though showing the biggest increase in three years with 112,000 new jobs, missed that target. And it fell far short of an earlier Bush Administration forecast of average monthly job growth of 300,000 for this year. Naroff says 200,000 new jobs a month in the payroll survey would be considered solid, and anything above 250,000 would be strong. "That's what we would like to see," he says.
Not everyone is convinced that job growth will be key to a continuing recovery. Donald Luskin, chief investment officer at TrendMacrolytics in Menlo Park, Calif., argues that the unemployment rate is a very tame 5.6% by historical standards. "We are in a perfectly fine, better-than-average recovery," he contends, and it won't matter to the stock market what happens with jobs or productivity as long as profits rise.
Still, 2004 will likely be a year of diminished expectations. First Call/Thomson Financial is forecasting 13% earnings growth year-over-year -- good but not great. The market is expected to log gains in the high single digits vs. the 26% rise in the Standard & Poor's 500-stock index in 2003. Chances are that if the rebound continues, job creation should eventually see some improvement. Jobless Americans can only hope that employers become confident enough about the economy to start hiring again. Investors, too, would hail that development.
Walhgren covers the markets for BusinessWeek Online
Edited by Patricia O'Connell