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

1. STEVEN KACZMAREK
GENE D. BALAS, CFA
631 574 2474
Info@EastEndWealthManagement.com
www.EastEndWealthManagement.com
L ayups versus L ayoffs
november 2013
Why Employment is S tuck in Low Gear
Introduction
W
e 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 employeeemployer 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, dividendhike lay-up?

2. 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
Business
and the
Ease
of
Doing
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.
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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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3. 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
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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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4. 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 info@eastendwealthmanagement.
com to continue the discussion.
For more information on East End Wealth Management, including our performance results, please visit our website:
www.eastendwealthmanagement.com
This information is intended to describe a general investment strategy and is not a recommendation to buy or sell any specific securities. The
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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
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5. B iographies
STEVEN KACZMAREK
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.
gene d. balas, cfa
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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