Good news can in some ways be self defeating. Unfortunately for the millions of unemployed in the United States the global recovery has been accompanied by surging input costs. With weak end demand these costs are being largely eaten by corporations. Thus far margin expansion has been the key factor in the profit rebound. With troughing unit labor costs and rising input costs we’re likely to begin seeing margin compression as we head into 2011. With meager revenue growth that’s not necessarily a net negative, but it will create a continuing defensive position for corporations and likely result in a tepid hiring process. S&P elaborates on the margin compression of 2011:
“Nonfinancials, excluding oil and gas and utilities, posted 18.5% growth in EBITDA on a 6.6% increase in revenue for the 12-months ending in September 2010 versus the same period a year earlier (based on a sample of 690 nonfinancial companies). Margins have been buoyed by limited wage growth and strong cost control. Indeed, in the second quarter, profit per unit of output for nonfinancial corporates grew at an annualized rate of 21.7%, as unit labor costs rose less than 1% and nonlabor costs fell slightly (see chart 1). This put the profit share of total nonfinancial corporate value added at 12.9% in the second quarter, the highest level since the third quarter of 2006 and well above the cyclical low of 9.4%, but also above the average of the past decade.
As we move into 2011, corporations could have a harder time expanding margins, a pattern that has already begun to emerge. Nonfinancial margins grew at a slower rate quarter-over-quarter in the third quarter of 2010, and almost half of our sample of 690 nonfinancial companies saw margins decline. One reason for this is that companies are facing higher crude input costs. Commodities prices, such as industrial metals, grains, and softs, are up 53%, 53%, and 21%, respectively, between Dec. 9, 2010, and the end of June 2010. We expect companies will have to absorb most of the increase in raw material costs as demand may not yet be strong enough to fully pass costs down to consumers. With labor costs already past their cyclical low, companies will be hard-pressed to expand margins until consumer demand strengthens.”