Why Record Corporate Profits Aren’t that Great

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Tomorrow the government will announce the jobs number for November. Companies are expected to have added nearly 150,000 jobs last month. That’s not a lot compared to the millions people who are out of work. Indeed, the unemployment rate is not expect to fall from its current 9.6%. But if the jobs number is even lower than expected, here’s the reason: Corporate profits are not as strong as they look. What’s more, it’s not earnings growth that produces hiring. It’s sustained earnings growth that produces hiring. And that’s where we may have a problem. Here’s why:

Just before Thanksgiving we got the news that corporate profits hit a record high in the third quarter. All told, companies earned nearly $1.7 trillion in the third quarter. Some commentators have pointed out that if you inflation adjust the numbers, profits are not as high as they were back in 2006. That’s fine. But even after that analysis it looks like profits are growing nicely.

According to Standard & Poors, Profits at the companies in the Standard & Poors 500 rose an average of nearly 37%. Not bad at all. So why haven’t those profits translated into more hirings?

The first answer is because a good deal of those profits are from cost cutting–i.e. firing people. Revenue for companies in the S&P 500 only rose by 5.5% in the third quarter. Nonetheless, as we have seen from the drop in mass layoff claims, and the downward trend in new jobless claims, that firing was mostly happening last year, and the early part of this year. The normal cycle is layoffs and then profits, which leads back to hiring. We should be entering that third part of the cycle now, but there is a chance we won’t or it will be delayed. Why is that?

Look at where the profits came from. The biggest gainer in the third quarter was the banking sector. Profits at financial companies jumped 191%. Yet revenues at those firms actually fell 6%. No new sales, no new employees.

In fact, financial firms accounted for more than a third of the profit growth in the third quarter. Strip out the banks, and the increase in income drops to 23%. That’s still not bad. But here’s the problem: By this time next year, even that run up in profits will have significantly melted away.  For 2011, profits growth is expected to be 13%.

Again, not bad, you say. It is double digits. Yes, but we’re in the second year of an economic rebound. Similar times have produced much higher growth. In 2003, profits jumped 19%. Corporate income spiked 29% in 2003. So while corporate profits may have looked strong, that strength may have only been on the surface, and it may be fleeting. And that means we may still be a year or more away from a robust job market.