Wall Street is getting nervous, with stocks slipping and then rebounding as the latest data comes in. What has got everyone worried isn't an old-fashioned recession though. It's an "earnings recession" — the "earnings" in this case being "earnings per share," i.e. the money that companies spit out to their shareholders.
And as it turns out, an earnings recession is probably good news for Americans as a whole.
Most everyone will tell you that the stock market isn't the real economy. But it's worth digging into exactly what we mean by that. Wall Street and the stock markets are driven by payouts to shareholders, usually via dividends. And those payouts are taken from company revenues. But they're only one of several things that companies direct their revenue towards; there's also new jobs for new workers, higher wages for existing workers, and investments in physical capital and expansions.
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The reason observers sometimes treat the stock market as a stand-in for the real economy is they assume all these things rise and fall together: If a company has more money to give to shareholders, it's because it has more money to give to workers and investments as well. Conversely, if a company has less money for shareholders, it must have less money for those other priorities too.
And sure, sometimes it works that way. But sometimes it doesn't.
For instance, during a multi-year stretch after the Great Recession, unemployment was high and the economy was stuck in the doldrums, but corporate profits were higher than they'd been in decades. In fact, the high unemployment was a big part of why corporate profits were booming: When lots of people are desperate for work, they'll generally take whatever employment companies offer, which undercuts the ability of workers everywhere to demand better pay — and thus a bigger cut of the revenue pie. The fact that unionization in the private sector is a shadow of its mid-century self only exacerbated the problem. As a result, companies could get the same amount of work out of their employees for less money, and had more left over to give to Wall Street.
Corporations can also use other gimmicks — like share buybacks, mergers, and growing monopoly power over markets — to juice their profit margins even if real economic fundamentals aren't improving.
But the disconnect can work in the opposite direction as well. Let's say the economy recovers enough that unemployment gets really low, and businesses start running out of available workers. Americans will gain more leverage to demand higher wages across the board. And as competition between companies for all sorts of resources heats up — labor being the foremost, but also other inputs like raw materials and financial credit — all those costs will rise, eating up a bigger slice of the revenue pie, and profits will fall even as the economy keeps improving.
That gets us back to Wall Street's current skittishness. Because it sure looks like that last scenario is exactly what is happening now. Analysts project that earnings per share will drop 0.4 percent for the three-month period between now and June, compared to the same timeframe a year ago. And that's on top of a 4.6 percent drop already estimated for the first three months of 2019. The kicker is that this is happening even as overall corporate revenues are rising: up 4.8 percent in the first quarter alone.
By all accounts, the key culprit is the rising cost of paying workers, along with other needs. "Companies are experiencing rising input costs as well as increases in labor costs from modestly rising wages," Kristina Hooper, the chief global market strategist at Invesco, told Reuters. An equity analyst at Morgan Stanley, Micheal Wilson, echoed that conclusion, telling the outlet that "wage pressures appear to be rising. [Wilson] noted that the number of mentions of labor costs during earnings calls in the last reporting period was the highest since 2005."
Granted, America's 3.8 percent unemployment rate probably isn't giving workers the same amount of leverage they had the last time unemployment got this low. There are multiple reasons for that, particularly the fall in the labor force participation rate, which suggests headline unemployment is undercounting the true amount of joblessness.
Some of those rising costs are also probably due to President Trump's trade war. Companies are being forced to pay more for what they're already importing, or to switch to more expensive alternatives. And so far, there's scant evidence that forcing that switch is doing anything to boost the economy.
But, big picture, there's no doubt the economy is finally heating up. Nominal wage growth still has a ways to go to get back to previous booms, but it's sped up noticeably in the last year.
Another perennial habit of Wall Street observers is to assume that good times must always be followed by a fall. Thus, fears of an "earnings per share" recession are bleeding into fears of a recession, period.
Certainly, the U.S. economy has been stuck in a boom and bust cycle for a while. But that's more to do with the bad macroeconomic management we keep getting caught in, as opposed to any law of nature. If the economy tanks in the next few years, it will be because the Federal Reserve gets trigger happy about inflation and hikes rates too quickly. (Fortunately, this possibility seems to be receding.) Or it will be because corporations decided to skip the healthy route to growth — which requires eating lower profit margins as the price of financing investment — and instead relied on debt to fuel expansions or to juice shareholder payouts.
Long story short, there's no inherent reason the boom can't continue. But first we have to realize that what's bad for Wall Street can be good for everyone else.
