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By ZACHARY KARABELL
Despite grim predictions, most major U.S. companies have reported
positive earnings
for the second quarter of 2009. Given how wrong past
predictions have been, the fact that earnings have blown away
expectations
shouldn’t be so surprising. Still, the numbers are
genuinely impressive: More than 73% of the companies that have
reported
so far have beaten earnings estimates—and stocks have rightly
rallied.
Yes, profits are down sharply from
a year ago, but this is in the
context of an overall global economy that is shrinking. If a company
made $30 million
on $100 million in revenue a year ago, and made
“only” $20 million this quarter, it’s accurate to have
a headline that
says its profits fell 33%. But making $20 million, or a 20% margin, in
an economy that contracted is
nonetheless startling, or should be.
The same Wall Street culture that failed to anticipate the tipping
point in
the financial system is just as prone to a herd mentality of
negativity. Having overlooked the gaping fissures in the system
last
year, most analysts went to the other extreme in their analysis of
what would happen this year. A similar process
occurred in 2002 and
2003, as views whipsawed from unrealistic optimism to irrational
pessimism.
This time, the
slew of better earnings has also led to the conviction
that the worst of the economic travails are behind us. As the stock
market
has soared, many have declared the recession either over or
ending. These voices range from public officials at the Federal
Reserve
to notable pessimists such as New York University economist
Nouriel Roubini. This rosy view assumes a connection between
how
listed companies are fairing and how the national economy will fair.
That assumption is wrong.
The delinkage
of the fate of corporate profits from that of the
overall economy is not new. Beginning earlier in this decade, profits
began
to accelerate far in excess of either global or U.S. economic
growth.
In 2004, for instance, earnings for the S&P
500 grew 22%; in 2005 and
2006 they grew just under 20%. Those same years global growth barely
exceeded 3%. As we now
know, some of those elevated earnings were due
to the leverage-fueled profits of the financial-service industry. And
there’s
little doubt that mortgage-laced derivatives artificially
elevated growth. But even discounting those factors, the growth
of
corporate profits would have substantially exceeded the expansion of
national economies.
Then, in the second
half of last year and the first months of this
year, profits plunged along with U.S. and global economic activity.
That
gave succor to the belief that companies can only grow as much as
the economies in which they function grow. For years,
most analysts
argued that if there was too wide a variance between the two,
something had to give. Either profits had
to descend or national
economic growth had to accelerate. As profits shrank over the past
nine months, those who argued
that a reversion to the mean was
inevitable seemed to be vindicated. But that belief is wrong.
Companies are increasingly
less constrained by any national economy,
and their success is no harbinger of national economic growth or
sustained
economic health for the United States.
First, companies have been profiting because they can cut costs
aggressively.
It’s not as if demand in the U.S. or Europe has picked
up. Take Starbucks, which reported a surprising surge in profits.
Little
of that was due to American consumers suddenly becoming
comfortable with $5 grande mocha lattes. Instead, it was because
Starbucks—faced
with weak demand and sluggish sales—closed stores and
laid off workers. That has been a trend across industries.
Second,
many larger companies have been profiting because they can
focus on where the growth is around the globe. Companies such
as
Intel, Caterpillar, Microsoft and IBM now derive a majority of their
revenues from outside the U.S., with the dynamic
economies of the
Asian rim and above all China assuming an ever-larger role. Companies
are thriving in spite of economic
activity in the U.S., not because of
it.
That suggests the connection between corporate profits and robust
economic
recovery in the U.S. is tenuous at best. In fact, the
financial crisis hastened the trend toward efficiencies, toward leaner
inventories,
and towards integrating both technology and global supply
chains that has been taking place over the past decade.
That
has led to severe pressure on the American working class and
eroding employment. As these companies profit from global
expansion
and greater efficiency, they have little or no reason to rehire fired
workers, or to expand their work force
in a U.S. that is barely
growing. If you are a global company, you want to hire and expand
where the most dynamic growth
is. Unfortunately for Americans, that’s
not the U.S.
So we are facing a conundrum: Companies can grow by leaps
and
bounds—by double-digits—and yet unemployment can skyrocket and remain
high. There is nothing on the
horizon that would lead one to expect a
turnaround in the employment picture.
Job losses slowed slightly last month
as the unemployment rate fell to
9.4% in July from 9.5% in June, but that’s a far cry from any sign of
job creation.
The weight of more than 20 million marginally employed
or unemployed, combined with the increasing pace of economic activity
outside
the U.S., presents the prospect of permanent change in the
American economic landscape: high unemployment, moderate to
weak
growth, and soaring corporate profits.
The ability of companies—large ones especially, but even more
modest
ventures that assemble and source globally—to become more efficient
and go where the growth is has never
been greater. This is undoubtedly
good for stocks and positive for investors, but it is also a challenge
for American
society that we have not even begun to confront.
Mr. Karabell is president of River Twice Research. His new book,
“Superfusion:
How China and America Became One Economy and Why the
World’s Prosperity Depends on It,” will be published by
Simon &
Schuster in October.
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