US Productivity Puzzle Could Lead to Upside Surprise

A first-quarter productivity slump fueled concerns about the US economy, but second-quarter labor and company earnings data indicate better productivity and underlying growth. In short, the data point to a US economic cycle that’s broader and stronger than it appears on the surface.

Labor productivity in the first quarter is almost sure to be reported as posting one of the largest declines ever during an economic expansion in the post–World War II period. The initial estimate of a 3.2% annualized decline in nonfarm productivity will shortly be revised downward, to 5% or more, due to the sharp downward final revision to first-quarter real gross domestic product (GDP), which is used to estimate productivity.

Historically, such sharp productivity declines haven’t happened often, and when they have, it’s been during recessions—not expansions. It’s too early to say whether the recent drop was a fluke, a result of faulty data or a measurement error. The productivity drop reflected in GDP (the output side of the economy) is also seen in gross domestic income (GDI, the income side), and is supported by a sharp drop in corporate profit margins.

But other indicators paint a different picture.

Payrolls and Hours Provide a Clear, Positive Statement

We would expect businesses to have been more cautious with labor in the second quarter, with margins under pressure, but survey data show that private payroll job growth accelerated to 255,000 per month, up from 189,000 in the first quarter. And hours worked rose 4.4% annualized—over three times the first-quarter growth rate (Display) and the largest quarterly gain since 2006. This is a clear statement by businesses that there was enough demand growth—maybe including unfinished work from the bad winter—to bolster hours.

It also raises doubts about the accuracy of the consensus estimate of 3%–3.5% for second-quarter real GDP growth. With GDP growth lagging the 4.4% growth in hours worked by about 1%, productivity should be declining, squeezing corporate margins and earnings. But early reports of second-quarter operating earnings for US companies don’t show a squeeze on either measure.

Early Earnings Signals Are Strong

We’re still in the midst of the earnings reporting cycle, but for the 40% or so of S&P 500 companies that have reported, second-quarter earnings are up almost 9% year over year. If we conservatively incorporate the rest of the companies using consensus estimates, blended earnings growth is over 6%—slightly above the 5%–6% consensus. If these earnings trends hold up, it would indicate that second-quarter productivity rose substantially—and that GDP increased by more than the 4.4% annualized growth in hours worked.

The big gap between the major components of GDI and GDP data raises the question: which paints a clearer picture of underlying US economic growth?

Piecing the Puzzle Together

Some research supports the case for GDI as a better indicator of business-cycle fluctuations, but the productivity puzzle isn’t likely to be solved soon, even with the initial report on second-quarter GDP scheduled for July 30. That’s because GDP will still be based on preliminary reports for several key sectors and guesstimates for others. The first official estimate for GDI won’t show up until the end of August.

But the whole puzzle doesn’t need to be solved for investors and policymakers to get a sense of the true productivity trend. If second-quarter corporate earnings remain on their current pace, it will bolster the case for profit-margin gains and a big productivity rebound. And if the July employment report (scheduled for August 1) shows gains on par with those of the second-quarter monthly average, it will reinforce that companies see continued gains in demand along with strong earnings potential—helped by productivity gains.

We’ll get another key data point on August 8, when the US Bureau of Labor Statistics releases its final revision for first-quarter productivity and an initial estimate for second-quarter productivity. We think there’s a good chance that the second-quarter numbers will be a pleasant upside surprise.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Joseph G. Carson

Director—Global Economic Research
Joseph G. Carson joined the firm in 2001. He oversees the Economic Analysis team for Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor’s All-Star Team for Fixed Income. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees. He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Location: New York

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