One of the most important economic trends to emerge in recent years is that gains in corporate profitability are not translating to wage increases or more hiring. The New York Times just published an article on this disconnect, but it’s nothing new. The basic story is simple. Even as corporate profits have increased at a healthy clip, there has not been a similar gain for workers in terms of new hiring or increased compensation for current employees.
Consider the following statistics from the NY Times piece:
- The share of corporate income that went to employees is at its lowest levels since 1966.
- Corporate earnings have increased at an annualized rate of 20.1% since the end of 2008 while household disposable income increased at an annualized rate of 1.4% over the same period.
These statistical measures are not conclusive, but they are indicative of the shift that we are seeing. Companies are doing more with less employee input and, of course, the fact that more companies are seeking out countries with the lowest wages helps companies at the same time that it disadvantages U.S. workers.
Part of the increase in corporate profitability in a time of stagnating wages is, of course, due to technology, which allows companies to produce more with less input from workers. Technology inexorably increases profitability to owners and reduces the total cost of human labor for products and services.
The challenge of how to deal with the displacement of workers by technology is nothing new. The term ‘luddite,’ which refers to someone who resists the introduction of new technology, originates from 19th century textile workers who violently resisted the use of technology that displaced them with lower-skilled and, presumably, cheaper workers. In a recent book, Race Against The Machines, MIT professors describe how technology is displacing human workers in even highly-skilled jobs such as legal research. There is a well-known example in the field of radiology, for example, in which the reading of medical x-rays for U.S. patients is performed by doctors in India.
Whether the downward pressure on wages is due to globalization or technology or both, the implications for workers, consumers, and investors are substantial. On one hand, technology and globalization make a wide range of products and services cheaper for consumers. If you are a wage earner, however, you are also likely to experience downward pressure on your income unless you do work that is either (1) sufficiently specialized or (2) sufficiently hard to have done by the cheapest global source.
What sectors of the economy will be hardest hit and which will thrive in this environment? Firms that can and do outsource their labor to the lowest-cost countries will probably do well in terms of earnings. Their challenge, however, is a race to the bottom on manufacturing costs. Computer hardware is a key example. Ultimately, computer hardware firms will have a hard time generating attractive earnings unless they can become the lowest-cost provider. So, too, will companies that produce other goods for which manufacturing is easily relocated to take advantage of the lowest labor and infrastructure costs. As U.S. wages remain flat, or even decline, big-ticket discretionary purchases such as automobiles will be delayed for as long as possible. Residential real estate is also likely to see limited price appreciation for an extended period of time (once the current period of record-low interest rates ends), simply because fewer young people will be able to purchase homes due to low wages for recent graduates and, of course, student debt relative to wages. So, the data suggests a slow recovery for the consumer-driven parts of the economy.
What sectors will do well? First, we have energy production and infrastructure. We are at the start of a massive boom in energy production in the U.S. We have discovered huge reserves of natural gas and the jobs involved cannot be shipped to other countries. As energy prices in the U.S. are held down by the higher production, companies that require large amounts of energy to produce their products will have a substantial edge on global competitors. While the producers of natural gas have been hurt by lower prices resulting from increased production, the companies that own pipelines and storage have done well. These include firms such as Kinder Morgan (KMP) and Enterprise Products Partners (EPD). These companies are part of the MLP sector, which should broadly benefit from increased production, even if gas prices remain low.
A recent Economist article cites Dow as a major beneficiary of low domestic energy costs because they use a great deal of energy as inputs to their production. Lower natural gas prices also help to hold down the price of electricity, so companies with huge server farms will get a boost to their bottom line. As an aside, low natural gas prices also tend to hurt companies in the alternative energy business such as solar cell manufacturers.
Another area that is likely to thrive in this economy is businesses that help consumers find the best prices on the goods that they do buy, whether these goods are new or used. eBay (EBAY) and Amazon (AMZN) are clearly well-positioned to serve a world of more cost-conscious consumers. Pawnshops are also a booming part of the economy and there are a number of publicly-listed pawnshop chains (CSH, EZPW, FCFS). Used cars are a booming marketplace and companies such as CarMax (KMX), KAR Auction Services (KAR), and Copart (CPRT) have benefited. While these stocks are fairly expensive today, the sector as a whole is worth keeping an eye on. Furthermore, as consumers strive to extend the lives of their existing autos, parts chains such as AutoZone (AZO) will probably do well.
Finally, if economic growth in consumer-driven sectors is muted, stable income-generating businesses look attractive. Utilities and telecom firms are staples. The U.S. telecom and utility sectors are fairly expensive today, but there are international alternatives that are more attractively valued.
There is a clear shift in economic power away from U.S. workers, as companies can increasingly generate high earnings with fewer domestic workers. Both workers and investors will do well to recognize these trends.
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