A Profit "Recovery" Driven By Plunging Labor Costs Explains Why PE Multiples Will Remain Depressed

Tyler Durden's picture

In addition to the traditional (and much discredited) argument of quadrillions of cash on the sidelines (which conveniently ignores the quintillions of debt also on the sidelines), the other last remaining point that bullish pundit like to point out is that the PE on the S&P is oh so very low compared to historical level. Putting aside the fact that the last 30 years of economic data have been perverted by a cost of credit which has declined from 15% all the way to zero, and with no additional place to go, and as such any historical comparisons are now moot as the Fed is pretty much out of options (aside from monetizing of course, and outright debasing the dollar), the primary reason why investors continue to put little credit in the "miraculous" corporate profits explosion, and thus give companies subpar P/E, is that the entire profit recovery has been predicated not on GDP growth (which explains the constant skittishness about macro events), but on declining labor costs, and as the following JPM report points out, "the latest profit recovery (the three red dots) is reliant on declining labor costs like none before it." What investors really want to know is how much more wage deflation can America take before it all collapses into a huge stinking deflationary mess? And by sowing the seeds of deflation at the heart of the corporate economy, who in their right mind would expect a wage-driven inflation (a monetary-event catalyzed hyperinflation, in which the Fed just goes berserk and decides to print $1 quadrillion tomorrow, is a different topic altogether).

More from JPMorgan:

These deflationary trends surface some important questions about corporate profits, which have beaten expectations for the last 5 quarters. As shown below, a proxy for profits (nominal GDP growth less unit labor costs) is growing at a healthy clip, which usually indicates recovery rather than recession. But let’s decompose this profit proxy for a moment, looking specifically at periods when it’s rising faster than 5%. Most of the time, a profit proxy of 5% or more reflects healthy nominal GDP growth in excess of still-rising unit labor costs. But the latest profit recovery (the three red dots) is reliant on declining labor costs like none before it. A profit recovery whose foundation is so reliant on sustained high productivity and low real wage growth should not command a very high P/E multiple.

So the next time some permabull tells you P/E multiples are low, low, low, tell them that they are only low as the alterantive would be to be bidding up corporates in a deflationary environment, which in a Catch 22 loop, becomes even more deflationary precisely due to this record profitability. Perversely, investors would gladly pay for much bigger PE's if companies actually paid bigger wages to more people. But they continue to refuse to... and so that whole conversation is moot.

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knukles's picture

The dude from UBS caddies?

Mr Lennon Hendrix's picture

I think you got that backwards ;)

BORT's picture

He was wearing his knee pads today.  As my old boss used to say:  "I'm only going to show you this once"

Astute Investor's picture

BHO was golfing with his friend and former college roomate, Mitch Cumsteen....

Ragnarok's picture

Is that the cocaine dealer he used to get high with and then they'd "experiment"?

Mr Lennon Hendrix's picture

Well with a name like that!

***Note to self, juvenile remark of the day used.***

-Michelle-'s picture

The first story is from 2009, though I suppose it wouldn't make much difference.

Ragnarok's picture

Title is misleading, but this case has been ongoing for some time.

knukles's picture

 "historical comparisons are now moot as the Fed is pretty much out of options (aside from monetizing of course, and outright debasing the dollar"

Last time I looked at the Fed's balance sheet and the monetary base I'd suggest that  they've already exhausted that option. 

There is no center left to hold.

Running on Empty's picture

I have said this over and over and over again. When they (Multinationals) outsourced all the manufacturing jobs they were nailing their own coffins, this will be the last nail.

Sudden Debt's picture

At least the Chinese are happy! And that's why we do it. Doesn't that make you proude?

midtowng's picture

The race to the bottom only works if someone else is paying workers enough to maintain consumption. When everyone is slashing wages then there is no workers out there that can consume. The world is glutted with production that no one needs. Any supply-side solutions to the depression are moot.

jeff montanye's picture

this is pretty much how it works through history, right?  long cycles of inflation then deflation.  the first part of each is lovely and stocks do well, bonds not so much in the inflation but quite well in the deflation.  the second parts of each cycle are less fun and stocks do poorly while gold appreciates.  things change yet stay the same.  though this time the treasury market may have more surprises for observers than it did in the '30's.


Sudden Debt's picture

This show how Ford manages to reduce the labor costs in a competitive way.

More should do it in this way:


Henry Chinaski's picture

PE on the S&P is oh so very low compared to historical level

Take profits in 2010 before taxes ratchet up.  Besides, cash flow is a fact. Profit is an opinion.

centerline's picture

Sure seems like bank analysts are increasing moving towards the negative.  Considering the big boys at these places are closer to the game than we are, it just makes me wonder... what's the angle here?

Mr Lennon Hendrix's picture

How much blood is left to run in the streets?

william the bastard's picture

You mean the Bildeburgers group decided at the last lodge meeting not to hire anyone in order to create wage deflation and loot the last remaing crumbs of the stinking middle class? Scumbags.

TooBearish's picture

And bankrupt the states so that their sovereignty is compromised and they are folded into the United Americas?

Dismal Scientist's picture

Since the 'E' in PE is easy to manipulate, and the analyst community's forward earnings are also nonsense, I find the metric meaningless. If you want to capture where companies are, use an EV calculation to incorporate the debt as well as the current price of the equity; and look at FCF relative to it. Will tell you a lot more about whether stocks are cheap or expensive. Forward analysis of FCF should highlight that interest expense will start to rise, working capital will get more and more pressured by unsold inventory and that top line will struggle. Thats a recipe for EV/FCF to rise next year over this year ... unless the EV number shrinks via the market price of the equity. Stocks are expensive.

JohnG's picture

Hi Dismal,

Yes.  E is easy to manipulate.  PE is irrelevant now.

FCF is yet another metric, that can be manipulated, overstated, shaky, etc.

What I'm interested on is intra-quarter CF, as this is what I see as "window dressing" for earnings.  Not so much FCF as these (imho) are guestimates at best.  Intra-quarter CF is hard to track with my tools.....





(noted for feedback)

Dismal Scientist's picture

Well, JG, I'm not aware of any datasource for intra quarter cashflow, short of being inside the company itself. The best we can do is model ourselves based on observation. The companies themselves are often in the dark, sadly.


gigeze787's picture

ZH -- link to JPM report...?

tom's picture

2q-3q09: Companies enjoy reduced costs from millions of layoffs, an unexpectedly small drop in consumption thanks to stimulus and safety net expansion, and deflating producer prices. Stocks melt up.

4q09-1q10: Company payrolls stabilize and slightly rebound, consumption stabilizes and slightly rebounds, producer prices rebound. Stocks decelerate.

2q10: Company payrolls flatten out, consumption flattens out, producer prices keep inflating. Stocks stagnate.

2h10: Company payrolls are shrinking, the stimulus that has been propping up consumption is tapering off, producer prices are still inflating. You make the call.

DarkMath's picture

So you're saying the H1B program that has helped depressed the salaries of engineers and scientist to third world levels has actually hurt the economy?

Oh my. I wonder if those depressed salaries have disuaded an entire generation of workers from entering science and engineering fields. If that's so then we may be dumbing down our society by creating too many Lawyers, Yoga Instructors, Physical Therapists, Motivational Speakers, Money Managers, Account Executives and White Rappers. Since those occupations rely on the largess of foreign governments buying our debt, if those strangers decide to pull back then we risks a massive employement crisis.

But I digress, I'm probably just awfulizing. Pay me no attention.

Thomas's picture

That is indeed dark math. In the past, a loss of interest in the sciences would have been met, eventually, with a demand for scientists. That will simply not materialize now. There are no breaks on the Tardmobile heading down into the abyss.

ElvisDog's picture

Most yoga instructors are hot and you get to watch them stretch. Definitely a profession we need more of.

Pillage's picture

Company cost cutting is at an all time high is it not? Are ceo's checking how many cups of coffee the employee's drink each day? Yet, HP can go out and pay more and more bidding up a buyout candidate. Are these companies buying out others leaving themselves that much more in danger with less cash of a credit crunch? I thought the whole idea of having a lot of cash on hand was to prepare for another credit freeze. Spend spend spend on an inorganic growth orgy and cut cost yet when all hell breaks as the economic data suggest is coming sell off inventory like no other.

Reese Bobby's picture

I could see stocks trading heavy further into the Depression...

Caviar Emptor's picture

All is not what it seems. During the Q3 2009-Q2 2010 record boom in secondary stock issuance by major corporations, much was done to hide the number of new shares issued which of course would dilute EPS. Several respected analysts noticed and commented on this, but were most likely threatened with a jack-booted knock at the door if they pursued the issue by recalculating EPS. 

Does anyone remember the "miraculous" BofA secondary where share prices INcreased on the offering date? As we've seen time and again, the laws of physics, finance and mathematics have been conveniently dispensed with.

TheMonetaryRed's picture


Wait a second, is the author suggesting that decades of outsourcing and "labor arbitrage" globalization are starting to result in the importation of third world wage rates?

Wow, who would have expected that?

You mean people with skills and the willingness to work are losing and people with money are winning?


Next thing you'll tell me is that when I go to the casino I'll get different odds than the house will get.

Quantum Noise's picture


Today, we have the same number of people working in goods-producing industries as we did in 1950, but 4 times a many finance jobs. Our worker-bean counter ratio went from 8-to-1 in 1950 to a 2-to-1 ratio today. Oh, and did I mention that since 2000 we've lost a full fucking third of goods-producing jobs? 18 million total manufacturing jobs and 14 million retail jobs. And the picture is even worse if you take out our safe military industrial complex manufacturing jobs.

themosmitsos's picture

Tyler, slightly off topic, but I'd like to hear more about the FASB regulations proposed AUG 17th. Anything new?

Also, neglecting to mention PE comps are "positive" vs 2009 earnings which are themselves only positive in comparison to one of the worst years on record, and should probably be flat or negative if they reflected reality (ie pick a "normal" year like 1997/8 or 2003/4).

Dburn's picture


It seems like each business sector is eviscerating the customers of other sector not to mention their own. Henry Ford should be rolling in grave with obviously wacky notion that the workers should be able to afford the products you make. Of course it took him 7 BKs to get that formula down among many others. When companies push wages down to inflate the already bloated corporate suite;   they all copy each other . They figure they are immune because the US accounts for 40% of their sales for a multinational globalist type of hide it here and hide there and hide it every where company.  Suddenly they are very concerned about the Chinese worker who decides you know $30 bucks a month and imprisonment at work  just isn't cutting it anymore. Those damnable people and their rising expectations. WTF? These execs bleed their fingers dry signing all those contracts and eating at all those 5 star restaurants to transfer all their technology over there and now the Chinese tell them they have to increase prices?

They are also finding out the much ballyhooed labor arbitrage is just not that simple. Wages too high, go to another country. Like you don't like the food at Andre's Dead Slime so you move to Vampire Squid's fresh roadkill. They find when they transfer ALL their tech to save that one extra penny then decide to go someplace else to save $20 a month on workers, the country you left who couldn't give a fuck about your patents, now is making it and selling all on eBay and their own sites for 20% of what the big smart American companies were charging because they don't need a 2 Billion dollar Manhatten Headquarters. If they make 5G a month, they are rich. Make 20-100G a month and they are front cover material for business magazines over there.Yeah they have their billionaires, but comparethe ratio towards their population. 

So they beat the American's pricing structure all to shit all over the world until the Americans look and say "wow,  we can't sell our southern tip of mongolian made iPads too for $700  is to these broke Americans". Time to take that Golden parachute and let some other slob worry about it.

Once people realize that these guys got to where they are by fellating the ones above them in  and knifing the ones beside them in their "meteoric " rise to the top, they will be real pleased to know that they don't know shit   and only execute strategy that McKinsey and the MBA Mob squad thinks up for them.

Then they should jump for sheer joy as they lose their $10/hour jobs to some jack-off who has  hundreds of millions worth of dated stock options in their hands if they are working and if they start fucking the help they get paid 40 million while your average employee is sued 30 ways from Sunday for sexual Harassment for patting a co-worker's shoulder and saying "you look nice today". Then they are  denied unemployment and blacklisted for ever by fine firms like Choicepoint and Lexis Nexus and even some of FICO's new lines of rating services. 

Yes Corporate America at it's finest. Participating in the surgical removal of all the assets a American worked their whole life for to build up their own security which isn't equal to a few hours of pay for them.

It can't come around soon enough and fast enough for us old folks to enjoy. Karma that is.


i.knoknot's picture


we buy barrels of oil from the arabs

instead of buying barrels of chemicals back from us, they buy dupont...

this doesn't bode well, does it...

MrTrader's picture

Question to the creators of this site : why don´t you rename your creation into "Doom Gloom & Boom Report" - and join Marc Faber ?

i.knoknot's picture

you don't think the zero-hedge name and byline are depressing enough?


i.knoknot's picture

i was roughly describing this very concept to a buddy a couple of weeks back:

"so, because of the 'recession'...  i go from being a company of 1000 folks making 1500 widgets per day to being a company of 10 folks making 20 widgets per day..."

technically speaking, my overhead is 1/100 and relative production is 33% higher.

time to buy *that* stock - oh boy, look at that company roar back to life...

globozart's picture


It doesn’t add up any more.  GDP nominal and per capita (PPP) is increasing but after inflation it’s falling for 30 years now. Are we getting more efficient or not. I mean we are flying bigger planes today, banksters are selling better packaged CDOs and one trader today can kill the whole bank.

But why is only the nominal GDP growing and not the real?

How can it be, even with government spending included, the US is producing less today than 30 years ago or is it just the trade deficit?


dcb's picture

hello official scam policy of our government and fed is as follows:

we will fix the economy by making 90% of the population poorer

Dollar Bill Hiccup's picture

Everyone one is worried about the economy and politics, but relatively no one seems to be thinking in terms of political economy. The two are never separate, are they? Think about it. Political Economy is not just discredited marxist rhetoric. Labor arbitrage must revert to the mean at some point, even if this point is not the revolution.

As the global political economy adapts one thing is certain. Americans will earn less, third worlders more. The FT had a piece a week or two ago explaining that call center workers in India were now being paid the equivalent of call center workers in the US. 

What remains a point of contention is that CEOs are paid some 300 x what the lowest paid workers earn in American corporations. 

And from a market viewpoint, what also remains illogical is the Chinese Communist party supporting mercantilist practices that have

boosted Foreign Direct Investment and exports, while driving consumption down to 35% of GDP and amassing $2.5 TN in foreign reserves as a result of those exports.

Does the Tea Party herald real change beyond slogans and sleight of hand? Can Americans endure sacrifice across the board, with those same CEOs held accountable as well? If not, we are in for even tougher times.  I'm for reality, not reality TV and the sooner we realize that these problems are ours, that we must all participate and face these problems and suffer together, the sooner we are on the road to recovery again. Can everyone be accountable?


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