As Profits Surge, Workers Still Wait

This is Wall Street’s version of comfort food: Corporate earnings keep rising at a double-digit pace while workers are lucky to get even low-single-digit wage increases.

For the last few years, those trends have been dependable and soothing for many stock market bulls -- if not for the average worker. It’s a world in which share prices are underpinned by healthy earnings while inflation risks are muted because employee pay isn’t in danger of an upward spiral.

The story continued in the third quarter ended Sept. 30. With nearly all of the companies in the blue-chip Standard & Poor’s 500 index now having reported their earnings for the period, the year-over-year growth rate was once again in double digits.

By S&P;’s reckoning, operating earnings for the S&P; 500 companies rose 11.5% in the quarter. It was the 14th straight quarter of double-digit growth, the data firm says.

Because profit growth rate calculations can vary depending on the definition of operating results (i.e., earnings before one-time gains or losses), the results look even better by some yardsticks. Boston-based Thomson Financial, another data cruncher, estimates that S&P; 500 profit rose 16% in the latest quarter.

In any case, the double-digit growth pace has gone on a lot longer than many analysts expected. For 2005 overall, S&P; expects blue-chip earnings to be up 13.4%. And it predicts an 11.5% rise next year.

As for the workers whose toil is producing these handsome results, wages and salaries for all private-industry employees rose 2.2% in the 12 months ended Sept. 30, according to the government’s employment cost index. That was down from a 2.6% increase in the year ended September 2004.

Add in benefits such as healthcare coverage, and total employment costs were up 3% in the most recent 12 months, compared with 3.7% in the previous period, government data show.

Now, there are many ways to measure compensation, and “average” pay gains can be as misleading as “average” earnings growth. For example, it’s logical to assume that employees of energy companies have a lot more to look forward to, pay-wise, than employees of auto companies, given the profit trends in those two industries.

But few on Wall Street would dispute that corporate earnings have been fattened in recent years in large part because the rewards of the economic expansion -- and spectacular gains in worker productivity -- have primarily flowed to companies’ bottom lines, not into employees’ pockets.

“It’s accurate to say that most of the productivity dividend has not gone to labor,” said Ken Goldstein, an economist for the Conference Board, a business-sponsored research organization.

Historically, companies have reaped most of the financial benefits of economic growth at the beginning of expansions, when workers are in relative excess supply and thus have less leverage to demand higher pay.

As expansions wear on, however, and the labor supply tightens, the pendulum is supposed to swing toward workers: They make more, at the expense of corporate earnings. Labor is, of course, the largest single expense for most companies.

“What’s different this time is it’s taking longer for the pendulum to swing back,” Goldstein said.

Based on the U.S. unemployment rate, which was 5% in October, down from 6% two years ago, workers arguably should feel more confident about demanding better wages. And in some occupations, especially technical ones in manufacturing, there’s no doubt they can.

Overall, though, compensation data suggest employees don’t believe that they have much leeway with the boss.

And that’s usually how most companies finally agree to share more of their profit with workers, says Milton Ezrati, an economic strategist at investment firm Lord, Abbett & Co. in Jersey City, N.J.: “It’s not largesse; it’s because of pressure” from employees who are ready to find a better job, he says.

Yet even with the unemployment rate falling for the last two years, there are legitimate reasons workers may not feel confident about their prospects. General Motors Corp.’s announcement last week of 30,000 job cuts was hardly a morale booster. And many people rightly believe that they’re now competing with other workers worldwide, not just within the U.S.

The fear is that “if you argue too loud that ‘I need more money,’ you’re going to get a pink slip,” Goldstein said. “Whether it’s true or not, that perception is out there.”

Still, some analysts believe that a financial shift in workers’ favor is inevitable if the economic expansion continues and the U.S. labor market continues to tighten.

By some pay measures, the numbers already are rising. The broadest government gauge of compensation, including stock option grants, was up 5.8% in the third quarter from a year earlier. The pace of increase has doubled from 3% early in 2003, although options grants often are rewards offered to workers already in higher pay levels, rather than to the rank and file.

Even so, Andrew Tilton, an economist at brokerage Goldman Sachs & Co. in New York, advised clients in a report this month to assume that workers in general would get a bigger piece of the profit pie in 2006.

“Compensation costs should continue to accelerate over the next year,” he said, in turn slowing corporate earnings to a single-digit growth pace, by his estimation.

And what would that mean for stocks’ bull market, now in its fourth year? Given the relatively muted gains in the prices of many shares over the last two years -- the S&P; 500 rose 9% in 2004 and is up just 4.7% this year, even as earnings have surged -- one could argue that the market already has steeled itself for slower profit growth.

What’s more, there are good reasons fatter wage gains for workers could be a positive for stock prices rather than a negative. The obvious one is that better pay would support consumer spending, the main driver of economic growth.

Also, happier workers could mean more successful companies in the long term, a concept even Wall Street ought to be able to grasp.

The big risk is the one that keeps Federal Reserve governors up at night: As companies raise wages, they also raise prices for their products or services, and enough so to start an inflationary spiral that the central bank would feel it had to quash with much higher interest rates.

Of course, it’s quite possible that projections of improving wages still are premature. Given how focused corporate managers have been on boosting earnings and hoarding cash for the last two years, they may be unwilling, or mentally unable, to change their tack.

Facing increasing pressure from hedge funds and other short-term-oriented shareholders to boost their stock prices, companies could contend that, with earnings growth rates declining (albeit still in double digits), now would be a bad time to give workers bigger raises. Instead, firms could say they need the cash for stock buybacks and other financial tricks aimed at pleasing Wall Street.

At that point, buy-and-hold investors should have a pay concern of their own: When does the obsession with today’s bottom line become ruinous to companies’ health, and stock prospects, in the long run?

Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to www.latimes.com/petruno.