Mid-July 2010
Investment Advisory Newsletter

Corporate Profits Vs. Job Creation

Second-quarter earnings reports are coming in, and they're making Wall Street smile. Corporate profits are up. And big American companies are sitting on a gigantic pile of money. The 500 largest non-financial firms held almost a trillion dollars in the second quarter, and that money pile is growing larger this quarter. Profits that plummeted in the recession have bounced back. Big businesses have recovered almost 90 percent of what they lost.

So with all this money and profit, they'll start hiring again, right? Wrong - for three reasons.

First, lots of their profits are coming from their overseas operations. So that's where they're investing and expanding production.

GM now sells more cars in China than it does in the US, and makes most of them there as well. The company now employs 32,000 hourly workers in China. But only 52,000 GM hourly workers remain in the United States - down from 468,000 in 1970.

GM isn't just hiring low-tech assembly workers in China. Last week the firm broke ground there on a $250 million advanced technology center to develop batteries and other alternative energy sources.

You and I and other American taxpayers still own over 60 percent of GM. We bought GM to save GM jobs, remember?

GM officials say no American taxpayer money is being used to expand in China. But money is fungible. Because of our generosity, GM can use the dollars it doesn't have to spend in the United States meeting its American payroll and repaying its creditors for new investments in China.

Second, big U.S. businesses are investing their cash in labor-saving technologies. This boosts their productivity, but not their payrolls.

Last Friday, for example, Ford reported a $2.6 billion second-quarter profit. The firm is already more than two-thirds the way to equaling its record 1999 profits. But due to labor-saving technologies, Ford now has half as many employees as it did a decade ago.

Wall Street analysts are happy with Ford's "commitment to keeping capacity in check," according to the Wall Street Journal. Ford shares rose 5.2 percent in one day last week. "Keeping capacity in check" is Wall Street's way of saying "no new hiring." In fact, the Street is advising investors to sell the stocks of companies that talk openly of expanding domestic capacity.

Finally, corporations are using their pile of money to pay dividends to their shareholders and buy back their own stock - thereby pushing up share prices.

Last Friday, GE announced it would raise its dividend by 20 percent and reinstate its share-buyback plan. It's GE's first dividend increase since the company cut its dividend in early 2009. As a result, GE shares are up more than 5% in the past few days.

Bottom line: Higher corporate profits no longer lead to higher employment. We're witnessing a great decoupling of company profits from jobs.

The next supply-side economist who tells you companies need more incentive (i.e. lower corporate taxes) before they'll hire is living on another planet.

The reality is this: Big American companies won't begin to think about hiring until they know American consumers will buy their products. The problem is, American consumers won't start buying again until they know they have reliable paychecks.

"Sixteen Tons" by Tennessee Ernie Ford

Arrowhead Asset Management manages Texas ORP/403(b) plan investments and money through Fidelity Investments (the largest no-load mutual funds group in north America) and the non-profit TIAA-CREF for . For IRA and brokerage accounts, we use the discount brokerage firm of Fidelity Institutional Wealth Services (IWS) for all small business and individual plans.