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Layups vs layoffs: Why Employment is Stuck In Low Gear

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Latest Paper from East End Wealth Management, explaining that political factors, profit incentives and skills gaps all conspire to restrain hiring.

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Page 1: Layups vs layoffs: Why Employment is Stuck In Low Gear

STEVEN KACZMAREKGENE D. BALAS, CFA631 574 2474Info@EastEndWealthManagement.comwww.EastEndWealthManagement.com

Layups versus LayoffsWhy empLoyment is stuck in LoW Gear

introduction

We ask a few most basic questions, “Why isn’t the economy growing, and why do we have such a problem

with high unemployment?” And more importantly, we ask, “How do we get the economy to grow faster?” Now that the recovery has progressed over four years since the recession ended, these are certainly valid questions.

At the heart of it is a seemingly circular logic, a vicious circle. Businesses aren’t hiring because revenues aren’t growing quickly, and employers cite impediments to expanding more broadly, including regulations and taxes, either now or at some point in the future. Companies also report that they have trouble filling many open positions. Revenues aren’t growing faster because consumers’ incomes from wages aren’t growing. The reality is somewhat more complicated. Corporate managers, whose compensation is linked closely to stock price, are more motivated to support the price of their stock rather than expand their businesses and take risk.

If a company plans a new product, expansion or hiring it is taking a risk. There is a possibility that the endeavor will not succeed. Corporate managers have found the recipe for their own success and compensation. Buying back stock and paying dividends has become Standard Operating Procedure for modern corporations. Less stock float means seemingly higher earnings, even if revenues are flat to negative. And there is a high degree of confidence that this process will be well received by investors, pushing the stock price higher. Hiring

new workers injects risk into a system that is increasingly risk adverse.

It is possible that managerial conservatism and government activism may have rewritten or are rewriting the employee-employer relationship. The results of this metamorphosis may be years in development, but it looks increasingly likely that the good old days are over.

Companies have been focused more on generating profits to return cash to shareholders through dividends and share repurchases. Activist Carl Icahn is pressuring Apple to pay out its cash hoard to shareholders, for example, through either dividends or share repurchases. This could help enrich investors, even if it means one less plant built or employee hired.

Other companies are retaining profits either at home or abroad. For companies with overseas operations, they have an incentive to ensure that the profits they earn abroad stay abroad, as those profits become taxable when they repatriate them back to the U.S.

Does this signal a lack of desire for companies to invest more in their businesses, expand, grow and hire? Perhaps it does signal a dearth of suitable investment opportunities here, if companies believe their U.S. sales will continue to be lackluster. What would motivate employers to hire more workers? What competes with the stock buyback, dividend-hike lay-up?

november 2013

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One important item to consider might be that employers often aren’t finding enough workers with the right skills to fill any open positions to allow them to grow more. Anecdotal reports do indicate that companies have hesitated to invest more in high-tech facilities that require a high tech workforce. Some companies simply haven’t found a large enough pool of qualified potential applicants.

In other words, there are too many workers with less training and too few with more. The result is growing income inequality, with high-skilled, highly educated workers commanding a greater income, while those who haven’t adapted to the changing economy face scant income gains. Average income statistics obscure the undercurrents of that dynamic. The end result is an economy stuck in low gear, with little opportunity for many of the unemployed. This fosters an environment in which the middle class is gradually disappearing, albeit at a quickening pace and the income gap between high-skilled workers and low-skilled workers is widening while corporate profits are expanding.

To think of the situation simplistically, we can consider what employers need and what workers offer, with the goal of this exercise to determine what would prompt the economy to grow faster and rehire the unemployed. However, we must also consider the motivation of the corporate manager, whose primary compensation is based on his company’s stock price. There are few available policy levers to address this situation, unfortunately, which explains why we believe the economy will continue to remain sluggish and unemployment to be persistently elevated. We will discuss some of the key issues facing businesses and what is holding back the economy.

reGuLations, taxes and the ease of doinG Business

Employers often cite regulation as an impediment to hiring. We can turn to several sets of data, first looking at what businesses cite in trade association surveys. In the National Federation of Independent Businesses (NFIB), a trade organization for small companies, we learn that the single biggest problem cited by small businesses is “government requirements and red tape,” with 22% of respondents citing that is their main challenge. The second most widely-cited factor is taxes at 21%.

For large companies, we can look to the Business Roundtable survey. In the most recent survey, the group included a special question concerning the effects of political stalemate in Washington, D.C. on economic conditions. Fifty percent of responding CEOs indicated that the ongoing disagreement in Washington over the 2014 budget and the debt ceiling is having a negative impact on their plans for hiring additional employees over the next six months.

We can also look at hiring trends and patterns by “red states” vs. “blue states.” We’ve used this definition as a proxy for the general level of regulations and taxes by states. Various organizations have published research into different statistics for the two groupings of states. CNBC conducted a comprehensive analysis of a broad spectrum of statistics across different states to determine and rank which states were the best for doing business. 24/7 Wall Street, a news organization, then used the CNBC data to categorize these states among red vs. blue.

24/7 Wall Street found that of the bottom ten states for business, six of those ten were blue states. Meanwhile, of the top ten states for business, eight of those ten were red states. They further analyzed unemployment rates by the best states for doing business, and determined that, based on data they used in May 2013, only one of the top ten states for doing business had an unemployment rate above the national average. Meanwhile, for the ten worst states for business in the CNBC report, six of 10 were above the national unemployment rate, which was 7.6% at the time of the analysis. Thus, we might surmise that red states are better for doing business and have a lower unemployment rate than is the case for other states.

In an earlier analysis, from 2012, USA Today determined that the income of those living in red states has climbed 4.6% since the recession began in December 2007. The average income of those living in blue states and swing states saw a much slower increase. The personal income of blue states has increased 0.5%, while in the swing states, income increased 1.4%.

LaBor force skiLLs

Let’s ask employers what they have to say. We’ll turn to those two surveys we cited earlier, the NFIB for small businesses and the Business Roundtable for big businesses. The NFIB commented in their most recent monthly survey, “Fifty-one percent of the owners hired or tried to hire in the last three months and 41% (80% of those trying to hire or hiring) reported few or no qualified applicants for open positions.” Eighty percent of those trying to hire or hiring were unable to find enough qualified applicants!

The Business Roundtable agrees: we do need to do more to educate our children and train our adult workforce. Here, businesses concur there is an essential role for government, particularly for providing a better education in our public schools. Its members cite the lack of preparedness in jobs requiring expertise in science, technology, engineering and math (STEM) fields – areas in which our students and workforce lacks – and where we fall behind in competing with other nations.

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Certainly, a lack of skills can impede businesses’ ability to grow and hire. The Wall Street Journal reported that, in a recent survey of Indiana manufacturers commissioned by Katz, Sapper & Miller, an Indianapolis-based accounting firm, 24% of the respondents reported “serious deficiencies” in math skills among their current workforces. Among respondents, 36% reported a serious shortage of skilled production workers.

One anecdotal report the Journal cited was that of Globalfoundries, a company which built a plant in upstate New York, a site chosen because it is close to two universities. The company attempted to fill 2,200 positions. The company had such a difficult time finding suitable local candidates that it recruited nearly half of those from elsewhere in the country – and still had to fill 11% of those jobs with people from outside the U.S.

LaBor market statistics

Difficulty finding the right applicants for skilled positions is easily seen in labor market statistics. We can look at unemployment rates by education level. For those aged 25 years or more with at least a bachelor’s degree, the unemployment rate is 3.7%. For those with some college, the rate is 6.0%, while those with just a high school diploma have an unemployment rate of 7.6%. And 10.3% of those aged 25 years old or more without a high school diploma are unemployed. (For all education levels for people 25 years old or older, the unemployment rate is 6.0%, with the difference between that rate and the 7.2% unemployment rate overall reflecting the very high youth unemployment rate.)

Today’s manufacturing facilities are often high-tech and require employees who have STEM skills, with a two-year or even four-year degree to operate complicated equipment that may require computer programming skills. Bayer Corporation conducted a recent study of hiring difficulties for STEM occupations. We learn that 68% of respondents report their companies have a significant number of open, unfilled jobs for four-year STEM degree holders because they cannot find an adequate number of qualified candidates. Meanwhile, 48% report vacancies for two-year STEM degree holders.

Not surprisingly, the industry sector with one of the highest hourly wages is information technology, with an hourly wage of $33.11, far above the $24.09 average for all industries. Information technology led the pack for pay increases, with hourly pay that increased 4.2% in the twelve months through September, double the average of 2.1% for all industries.

The sectors that had the lowest wages and the smallest wage gains were those requiring the least education: retail and leisure/hospitality, which includes food services. Here, wages were far below the average, at $16.64 for retail and $13.56

for leisure/hospitality. Wage gains have also been among the smallest, at 1.5% and 1.2%, respectively, over the past twelve months.

These two sectors have also been the ones hiring the most people; demand for low-skilled labor may be strong, but supply is even greater, keeping wage costs down. More specifically, retail trade has added 368,000 new employees in the past twelve months, while accommodation and food service has added 307,000 new positions. Combined, that’s 30% of the 2.2 million new jobs added in total over the past twelve months, even though these two sectors employ 20% of Americans.

Here is where we get to supply and demand. We have 675,000 people taking low wage jobs, even as reports we cited above say there are significant numbers of jobs going unfilled because workers do not have the right skills. We’ve noted unemployment rates by educational levels, and described the difficulties employers have in finding the right talent. If those low-skilled workers were instead available to fill higher-skilled positions, leading to a shortage of talent for those low-skills jobs, then those low-skilled jobs would pay more if employers had trouble filling those positions.

the effects on the economy

Having described the nature of supply and demand for labor and the impediments of unnecessary regulations, let’s consider what the result has been on the economy. It is here that we get to the crux of the matter: burgeoning corporate profits, even as wage gains are limited.

Data from the Bureau of Economic Analysis details corporate profits on not just large, publicly traded firms, but on all incorporated businesses. This is the most comprehensive set of data on the issue, especially as most Americans don’t work at Fortune 500 companies. Small and mid-sized businesses employ most Americans, so it’s important to look at trends for all businesses, not just on members of the S&P 500.

From the first quarter 2010 through the second quarter 2013, after tax corporate profits with certain adjustments expanded by an average annualized 5.8%. During this period, the average hourly wage increased by an annualized 2.0%. Inflation averaged 2.0% during the same period. In other words, there has been no growth in hourly wages, in real terms, since the end of 2009, but corporate profits have expanded by an average annual 3.8% after inflation.

Corporations have been passing along more of their incomes to their shareholders. In other data from the BEA, dividend income received by individuals has risen an average annualized 15.3% since January 2010. Wealth from share buybacks has added even more to wealth owned by those households who

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East End Wealth Management

This information is intended to describe a general investment strategy and is not a recommendation to buy or sell any specific securities. The strategy discussed does not and should not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. Any investment carries risk, including the loss of principal. Any investment strategy discussed here or available through East End Wealth Management is not an obligation of a bank and is not guaranteed by the FDIC and may lose money. Some investments are not suitable for all investors. Past performance is not indicative of future results. We cannot guarantee that this information is accurate or complete. As with any investment strategy, you should thoroughly discuss your particular investment situation and with your financial representative and understand any investment recommendation that might be made before investing any money.

East End Wealth Management is registered as an investment advisor with the States of New York, Florida and California. East End Wealth Management only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements.

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For more information on East End Wealth Management, including our performance results, please visit our website: www.eastendwealthmanagement.com

own stocks, including workers who own equity mutual funds in their 401(k) plans. Still, stock ownership is disproportionately owned by those on the upper tiers of the income distribution. Rising corporate profits while real wages remain stagnant further increases income inequality, which already is evident based on the lines of educational attainment and occupation.

Returning to the divergence of wages and corporate profits, the trend cannot continue indefinitely. When one company controls costs by limiting pay raises, it can increase its own profits. When all companies control costs by limiting pay raises, they can increase their profits – but only for a time. What is one company’s employee with scant pay raises is another company’s customer with little disposable income growth. A growing economy depends on consumers who have a growing source of income. When incomes aren’t growing, then it becomes difficult for the economy as a whole to expand.

concLusion

Limping payroll growth is holding back the economy. We may find that sluggish economic growth is here to stay. When corporate managers snub risk to support stock prices, they are doing what they think is best for them under the guise of what presumably is best for their company. Certainly, they are in good company: It is a corporate fad. Unfortunately this fad has the economy stuck in a low to no growth trajectory.

We do not pretend to have the right policy answers for this very complex dilemma; as it is, we have not even addressed many tangentially-related, yet still important, topics. We invite you, the reader, to let us know what your thoughts are on the subject. Send us a note to [email protected] to continue the discussion.

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BioGraphies

STEVEN KACZMAREK

gENE d. bAlAS, CfA

Steve is the President of East End Wealth Management. He has over 30 years of experience in trading and risk management in a wide range of markets. Most recently, Steve held the position of Managing Director at Legend Merchant Group. His background also includes the positions of Partner at Schonfeld Securities; a proprietary trading firm, NYMEX floor trader and Lieutenant, United States Army Reserve. Steve graduated New York University with a degree in Economics.

As an active member of the investing, planning and trading community, Steve is a member of NAIFA and the Financial Planning Association. Locally, he is the Chairman of the Southampton Youth Board, focused on youth issues on the East End of Long Island.

Balas has over twenty years’ experience in investment management. He currently writes economic commentary for TheStreet.com’s RealMoney site. Previously, he was Director of Investments at Genworth Financial Asset Management. In this role, he performed forecasts on macroeconomic conditions and determined the influences of thematic drivers to develop investment strategy, He also headed the firm’s manager due diligence efforts. Prior to GFAM, Gene was Director, Investment Management & Guidance at Merrill Lynch & Co. In that role, he advised pension funds, endowments and foundations as to appropriate asset allocation strategy. In previous roles, he advised both institutional and individual investors on asset allocation and manager selection decisions, beginning his career in 1989. He has an MBA from Columbia Business School and a BBA in Finance from the University of Houston, where he attended on a full National Merit scholarship. He is a Chartered Financial Analyst.

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