Profits and Employment: A Balancing Act

August 29, 2024 | Chad Sheaffer, CFA, CAIA, Associate Director of Private Credit

Following last week’s preliminary annual benchmark review from the Bureau of Labor Statistics that suggested U.S. job growth has been weaker than initially estimated, investors have been closely monitoring the labor market for signs of strain. Corporate profit margins may be particularly important to watch as they directly impact the labor market and have historically served as a leading indicator of layoffs and economic frailty.

Using the quarter-over-quarter percentage increase in average initial jobless claims as a proxy for changes in employment, this week’s chart highlights the relationship between the labor market and pre-tax corporate profit margins. Over the past three decades, corporate profit margins have generally trended higher and sit at approximately 12.2% today. While current margins are down slightly from recent cycle peaks, they remain elevated compared to historical levels. This signals that corporate profitability remains relatively robust. Despite challenges caused by higher rates and inflationary pressures, these higher margins have allowed companies to avoid significant layoffs by tapping into other cost-control measures as needed. Given that workforce reductions are often seen as a last resort for companies due to the high costs associated with obtaining, training, and retaining employees, significant layoffs typically do not occur until corporate profit margins have declined precipitously from cycle peaks. The orange line illustrates this point by showing sharp increases in initial jobless claims during economic downturns, including the Dot-Com Bubble, the Global Financial Crisis, and the COVID-19 pandemic, during which quarter-over-quarter jobless claims spiked by an astonishing 165%.

While there were certainly other dynamics at play during each of these recessionary periods, significant increases in layoffs generally coincided with slower growth and material declines in corporate profitability. These trends underscore the importance of monitoring these indicators in tandem.

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