Slowing corporate profits cloud the jobs pictureJuly 31, 2012: 11:21 AM ET
The 10-quarter winning streak for corporate profits is coming to an end. That doesn't bode well for the jobless.
FORTUNE – For nearly three years, corporate America's earnings soared higher even as joblessness persisted. But as numbers from the latest quarter come in, it looks like it may be the beginning of the end.
The slump is poised to eat away what little chance there was for the unemployment rate to fall much further this year. When the Labor Department releases its monthly jobs report Friday, what could turn out to be disappointing numbers shouldn't be much of a surprise.
Corporate profit growth has been one of the few bright spots in an otherwise tepid economy -- profits at U.S. companies listed on Standard & Poor's 500 have grown for at least 10 consecutive quarters. But for the past four months, if not longer according to some analysts, the rate of earnings has steadily declined as growth slowed in China and Europe, and remained weak in the U.S. As of March, corporate profits grew at an estimated annual rate of 4.8%. By June, that growth fell to 1.7%. Today, with about half of the S&P 500 companies having reported second quarter earnings, that growth stands at negative 1.6%, according to a report by FactSet released Friday.
Forecasters had expected profits to grow higher, but the outlook has turned negative as some of the most resilient companies – such as Starbucks (SBUX) and McDonald's (MCD) – missed Wall Street expectations.
Even when profits were strong, companies didn't hire much. The unemployment rate isn't expected to surge now that profit growth has slowed, but key indicators suggest that companies certainly won't create many more jobs during the rest of this year.
The ripest time for companies to hire is when sales rise and profit margins fall. This signals that consumers have an appetite to buy, while technologies that companies have invested in to improve operations aren't paying off like they used to. So companies will hire more workers.
But the opposite has been happening, says Paul Edelstein, economist with IHS Global Insight. "Job growth wasn't that strong to begin with," he says. "It doesn't look like it will get any better."
What earnings for the second quarter show so far is that the growth of sales, in particular, has slowed considerably. Of the 265 companies in the S&P that reported earnings as of Friday, only 43% reported actual sales above estimates. This compares with an average of 63% during the previous four quarters. The largest drop during the latest quarter comes from the energy industry, which has been struggling with declining commodity and oil prices as big consumers such as China cope with slower growth. The energy industry saw revenues drop 12.8% during the quarter, while all other industries across the S&P reported sales growth (albeit, slower).
As FactSet forecasters note, if companies reporting sales above estimates stay at 43%, that would mark the lowest percentage for a quarter since the first quarter of 2009 – just after the end of the recession.
Meanwhile, margins have risen – continuing a trend that started post recession as companies reluctant to hire invested instead in new machinery and equipment to drive profits higher. Whereas margins rose 9.2% (or $0.092 for each U.S. dollar of sales) during the first three months of 2012, margins for the second quarter are expected to rise slightly higher at 9.4%.
To be sure, companies will need to replace old machines and equipment. They've been doing some of that, but so long as companies can get decent returns, there's little incentive to hire many more workers. And given that sales will likely continue to slump, there's even less reason to increase headcount.