December 4, 2003
Yahoo! News Business - Forbes
By A. Gary Shilling, president of A. Gary Shilling & Co., economic consultants and investment advisersThe jobless recovery, much in the news lately, is a scary notion. That's why optimists seize upon any shred of evidence that employment is coming back, such as the small downtick in unemployment claims in mid-November. And we keep hearing that U.S. unemployment really isn't so bad after all - just 6.1% versus three percentage points higher in Europe. So there's nothing to worry about, right? Wrong. Layoffs are a key concern. And that will have baleful consequences for investors, who are betting on better times.
First, a resurgence in hiring is problematical. Companies just don't need more workers. Consumer demand isn't very robust. Despite the terrific news for third-quarter profits, the top lines - which drive hiring decisions - are again subdued for most U.S. corporations. And with global excess capacity and robust deflationary forces, pricing power is nil. Then there's the question of productivity. Business is producing more with fewer people. In the seven quarters, since the recovery supposedly started through Sept. 30, real gross domestic product was up 6.2% and payroll employment was down 0.8%.
The nation saw a productivity boom in the 1990s, chiefly powered by marvelous advances in information technology. Better labor training, more efficient staffing structures (fewer managers) and smarter corporate strategy were helpful. Today's better productivity, though, is catalyzed by layoffs.
Don't count on business anytime soon to step up capital spending, which could increase the need for more workers. Inventories are low in relation to sales and companies now prefer backlogs to more inventory on the shelves. Why hold inventory in a world beset by deflationary pressures? Also, there's too much excess industrial capacity and vacant commercial space to spawn an economy-loading capital spending boom.
Meanwhile, a host of other factors is stopping employers from adding to head count. Larger companies are facing requirements to restore depleted pension fund assets, a need that drains away capital. And everyone in the corporate world suffers from spiraling health care costs, one area of the economy that hasn't apparently heard about the end of inflation. The sober truth is that cutting costs is the only route to profits salvation these days. Most costs, directly or indirectly, are labor. And that means more layoffs.
These announcements just keep coming. Sprint, for instance, said on Nov. 24 it would lop 2,000 workers, 2.9% of its payroll. The latest manufacturing employment numbers (six months through October) show a 1.4% drop, about in line with a year ago. The average time someone spends unemployed is longer lately, a fact that isn't encouraging for the future: It hit 19.4 weeks in the May-October period, up from 17.0 in the same period in 2002.
Foolishly, bulls look at current earnings increases and see more strength ahead. Estimates show Standard & Poor's 500 reported earnings for the September quarter were up 27% from a year ago; operating earnings, which remove one-time expenses, were up 18%. Current lofty stock prices demand earnings gains of 20% next year.
Sorry, the party can't continue. Cost-cutting layoffs will squeeze consumer incomes. Fiscal and monetary stimuli, which masked the devastating effects of layoffs on consumer incomes, are fading, too.
The jump in mortgage rates this summer terminated the mortgage refinancings and home equity loans that have tided people over. The $400 Child Tax Credit, the only economy-thumping part of the 2003 tax cuts, has been long since spent at Wal-Mart. The big bulge in Iraq spending, $52 billion during the two-month-long hot war phase, is history.
The consumers, who have kept the economy going, are not going to be in the checkout lines. Their newfound zeal for saving will pinch spending further. The spillover to housing will break that bubble (see my Oct. 14, 2002 column) and seal the case for a 2004 recession.
The result: I foresee a profits decline next year with S&P 500 operating earnings down 9% to $49 per share and reported earnings down 13% to $39. What a blow to investors, who believe S&P's estimates of $62 per share for operating earnings next year and $56 for reported earnings! I hate to be the bearer of bad tidings. But if you expect the economy and the market to keep climbing next year, you will be sorely disappointed.