Look at the U.S. economy and you’ll notice an unusual disconnect.
The economy is being slowed by a tight job market, scant pay raises and weak business investment. Yet corporate profits are reaching record highs and fueling record stock prices.
How are companies managing to earn so much money in a sluggish economy? And why aren’t their profits goosing the economy?
For starters, weak job growth has held down pay. And since the recession struck six years ago, businesses have been relentless in cutting costs. They’ve also stockpiled cash rather than build new products or lines of business. And they’ve been earning larger chunks of their profits overseas.
All of which is a recipe for solid profits and tepid economic growth. The economy grew at a meager annual rate of just 1.8 percent in the first half of 2013. The unemployment rate is 7.2 percent, far above the 5 percent to 6 percent considered healthy.
Even so, corporate profits equaled 12.5 percent of the economy in the April-June quarter, just below a 60-year high reached two years ago. Profits of companies in the Standard & Poor’s 500 have nearly doubled since June 2009. Earnings appear to have risen again in the July-September quarter.
Big companies like Kellogg, FedEx and Best Buy have been slashing costs in the face of slowing revenue. Their strategy has been working: Despite sluggish revenue, their profits are up.
Burger King’s sales dropped last quarter as competition intensified. Yet the company’s earnings surged because it cut expenses and enjoyed growth overseas.
“Corporations have more market power than workers have and have kept wage growth to subdued levels,” says Dean Maki, an economist at Barclays. “That’s left more for corporate profits.”
Those solid earnings have helped boost stock prices. So has the Federal Reserve’s drive to keep long-term interest rates near record lows: Lower bond yields have led many investors to shift money out of bonds and into stocks, boosting prices.
The Dow Jones industrial average has jumped nearly 20 percent this year, closing at 15,639 on Monday, just below its record high.
“If we ended the year at these levels, it would be a phenomenal year,” said Bob Doll, chief equity strategist with Nuveen Asset Management.