Wages are increasing at the fastest rate in years. Corporate profits could suffer

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Elizabeth W. Kearley | Open moment | Getty Images

Workers receive higher wages, but at some point it could hurt corporate profits.

As the economy reopens, costs rise for everything from packaging and raw materials to shipping. In addition to these expenses, companies also pay more to bring in workers.

But the disparity between labor costs and profits has been so great for so long that employers should be able to raise wages if they can raise the prices of goods and services or improve productivity.

McDonald’s said last week it was raising wages for 36,500 hourly workers at company-owned stores by 10%, and Chipotle said it would increase wages to an average of $ 15 an hour. here at the end of June. Bank of America has said it will increase the minimum wage for hourly workers to $ 25 an hour, from the current $ 20, by 2025.

Sports equipment company Under Armor also announced that it will increase the minimum hourly wage for its retail and distribution employees to $ 15 from $ 10.

“This is one of the strongest wage increases we have seen in a quarter of a century,” said Mark Zandi, chief economist at Moody’s Analytics. He said the 3% wage growth of private sector workers in the first quarter was the strongest since the 1990s and productivity accelerated at the same time.

“All the anecdotes we have received in recent months suggest that this is continuing,” he said.

Attract talent in the event of a shortage

Employers are trying to alleviate a labor shortage, according to Jonathan Golub, chief U.S. equities strategist at Credit Suisse.

“The economy is overheating and businesses, even though we have a high unemployment rate, cannot get the labor force they need to meet the demand and they are forced to raise wages,” he said. he declared. “It’s happening with financial services. It’s happening in industry. It’s happening in retail. You see it everywhere.”

Golub said investors were right to ask when higher wage costs might put pressure on profit margins, but he doesn’t expect this to become an issue in the near term.

“If you see these pressures in an environment where the economy was weaker, it would be a disaster, but it isn’t,” he said. “We see it in an environment where companies have enormous pricing power, which means they can pass it on.”

But Sam Stovall, chief investment strategist at CFRA, said higher wages are one of the reasons he has turned neutral on the consumer discretionary sector, which includes retail and restaurants. The sector has only grown by 4.1% so far this year. It is one of the worst performing sectors, and it is lagging behind S&P 500.

“We have lowered our outlook on consumer discretionary because it is so dependent on the payroll,” Stovall said, noting that the sector is facing rising costs in many other areas as well. “Economists are calling for a 3% wage gain in the second half of the year and a continued gain next year.”

Golub said it’s unclear how long companies will be raising wages, but if it continues and becomes inflationary, it will be a problem for profits.

“If this represents a trend where people start to expect higher wages and they demand higher wages, and there is a continuation, yes it becomes a problem,” he said. “We don’t know if this is a one-time adjustment.”

The “rigidity” of higher wages

Unlike temporary increases in raw materials or goods affected by bottlenecks in the supply chain, labor costs remain on a company’s balance sheet.

“The context is extremely important,” said Golub of Credit Suisse. “We know that when the stimulus wears off, the economy is no longer overburdened, and the price of wood and gasoline goes down, people who got higher wages will continue to have higher wages. rigid. “

Golub said wages are not a short-term profitability issue and the market is focused on reopening trade now, not so much on margins.

“It’s not guaranteed to become a margin issue, but it poses a legitimate threat to margins,” he said.

“The markets react to such things and they should,” Golub added. “You can see it’s not by accident, but the administration and others have stressed that they want the workforce to get a bigger share of the economy.”

Golub said he recommends investors invest in cyclical sectors, which include industrials, materials and financials. These companies have strong demand and strong pricing power. “I think it’s gone for cyclical stocks,” he said.

Stress in the system

Economists said the labor shortage exposed April’s disappointing jobs report. Fair 266,000 jobs were added, about a quarter of what economists expected.

Stronger gains are expected in the coming months. Some economists expect more workers to show up in September when children return to school and also when extended unemployment benefits expire.

“Right now you are seeing more urgent wage increases due to labor shortages,” Moody’s Zandi said. “Things are likely to calm down around the fall as the economy catches up with supply and people get back to work and we are on the other side of the pandemic.”

Longer term, the workforce could remain tight even if the United States returns to full employment.

“It’s not a big deal this year, probably not next year, but as you move into 2023 or 2024 wages become more and more of an issue. Wage pressures will intensify and further reduce wages. corporate profits, ”Zandi said. “Businesses will try to raise prices.”

The ratio of total employee compensation to corporate profits has fallen steadily, from its peak of more than eight times in the early 1980s to nearly five times, Zandi noted. This means that the share of national income going to workers has fallen and has remained low as businesses have become more profitable.

“Compared to what has happened historically since World War II, companies get a very high share of the economic pie, not as high as ever, but it’s high,” he said. “Big business is very profitable.”

“The labor share has been very depressed … If everything pretty much sticks to the script, it should start to increase,” he said. “One of the policies of the new administration, in which they are working very hard, is to direct government support towards low and middle income households.

But Zandi said companies will likely invest in automation, even in the service sector. “They are going to invest more and more in technologies that save labor, which they have not done in recent decades because labor was cheap,” he said. declared.

Mike Englund, chief economist at Action Economics, said that strong 6.1% increase in personal income last year was due in part to the stimulus in fiscal stimulus payments, which will continue to boost revenues this year. He also expects employees to see higher wages, but by next year income could be stable.

This 6.1% gain the revenues came as corporate profits fell 5.8% last year, he noted.

Englund said the pandemic has resulted in permanent changes in employment. “We have probably reduced the size of the restaurant industry,” he said. Englund said the industry is likely to decline in cities like New York City, but could expand into the suburbs as many restaurants have added take-out.

One of the results of the pandemic is that people have left cities or moved to different regions. “With this change … we are seeing shortages, a mismatch,” he said.

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