The upside of lower profits, in two charts

at 04:33 PM ET, 04/11/2012

The market has been thrown for a loop this week, but the worst might be yet to come. Companies began announcing their first-quarter earnings Tuesday, and expectations are pretty pessimistic, with some analysts predicting the weakest year-on-year growth since the beginning of the financial crisis.

Still, there could a silver lining in lower earnings. FT’s Alphaville points out that labor costs per unit have been rising—in other words, that companies are having to pay more for workers, which they’ve been squeezing throughout the recession through slashed jobs, hours and pay.
That’s putting a squeeze on companies’ profit margins, but it’s good news for workers: it means there’s more demand for labor, and their wages have accordingly been on the rise:
Why is labor getting more expensive now? It’s partly because companies may have overcompensated during the recession by firing workers and squeezing more than possible out of the employees that stayed on, as Mark Zandi previously explained. Now they’re beginning to hire more, increasing demand for labor and wages.

However, as Alphaville notes, the Royal Bank of Canada points out that the trend also “ represents a double-edged sword: on the one hand, it would reflect a more self-sustaining economic recovery; on the other, it could dampen expectations of future earnings growth and translate into lower valuation multiples”—ultimately dragging down business activity and the broader economy.

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