Of all the worrisome economic numbers that have come out of the United States in the past couple of weeks, one of the more significant for the stock market may also be one of the more overlooked.
With gross domestic product, labour-market and Institute for Supply Management business-activity indicators grabbing the economic headlines, Thursday's quarterly report on U.S. productivity seems to have slipped under the radar.
But this number - a slim 1.3 per cent year-over-year growth pace, down from 6.7 per cent a year ago - may have as much bearing on stock values as any of those other indicators. Because productivity translates directly to the corporate bottom line - profits.
Productivity and earnings
"The first-quarter productivity figures show that U.S. firms have been finding it a lot harder over the past year to improve the efficiency of their work forces," wrote Paul Ashworth, chief U.S. economist at Capital Economics, in a note to clients.
After cutting staff to the bone during the recession, companies were able to enjoy a surge in productivity in the early stages of the recovery, as they ramped up production using fewer staff. But now, Mr. Ashworth said, they may have pushed that as far as it can go. "Productivity growth will probably remain pretty low for the next couple of years," he wrote.
He said this will likely translate into a slowdown in earnings growth - companies will find it harder and more expensive to grow from here.
A look at the relationship between productivity and S&P 500 earnings growth over much of the past 10 years strongly supports his prediction: Downturns in productivity have generally translated into slower earnings growth. The productivity slowdown since the middle of last year has been particularly mirrored by the slowing earnings expansion - stark evidence of just how much the current earnings cycle has been beholden to productivity gains.
Maybe good news for jobs
On the other hand, Mr. Ashworth also believes companies will have to start hiring again - which should be a positive for the U.S. economy and, by extension, the stock market. A healthier labour market not only boosts consumer demand but puts more money in the pockets of retail investors.
At a glance, the relationship between U.S. job growth and productivity doesn't look that strong over the past decade. But if we focus on just the last cycle of economic expansion - from 2002 to 2007, roughly - we can see that sluggish productivity growth and solid, sustainable labour-market growth did go hand in hand.
David Parkinson