5 Reasons Companies Still Aren't Hiring

Why strong earnings aren’t producing jobs.

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This is getting tiresome. Since late 2009, corporate profits have been surging, yet companies are hoarding cash instead of hiring more workers.

In the latest earnings period, three-quarters of all S&P 500 firms reported higher sales and profits, with the majority beating Wall Street's earnings estimates. And since last summer, S&P 500 earnings growth has been an astounding 55 percent, according to Bank of America Merrill Lynch. That's the best performance, by far, in any 12-month period following a recession.

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But a rebound in jobs is clearly not following the surge in profits. As we all know, hiring remains painfully weak, with the unemployment rate stuck at 9.5 percent and Americans gloomy about the future. The private sector is finally adding a few jobs, but government is shedding more. With the economy slowing, that unhappy trend could intensify—and unemployment could drift back toward 10 percent by the end of the year.

It's tempting to blame chief executives for the mismatch between strong profits and the weak job market. But the poobahs who get paid for strategic decision-making have several good reasons to exercise restraint. Here are a few of them:

The earnings surge is misleading. One reason those earnings numbers are so high is that they're being compared to abysmal lows. Companies reporting quarterly growth rates are comparing sales and earnings with the depressed levels of a year ago, a period close to the bottom of the recession when consumers and businesses alike had stopped most unnecessary spending. Take General Electric. Its earnings per share for the second quarter of 2010 grew a healthy 15 percent from the same period a year earlier. But total revenues and profits are still down sharply from the peaks of 2007 and 2008.

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It's the same story for most companies. While growth rates compared with 2009 have been impressive, total corporate profits probably won't return to pre-recession levels until the middle of 2011. So if you're a typical CEO looking at the big picture, your company still hasn't made up all the ground lost during the recession. "The economy is still under repair," says Dirk van Dijk, chief equity strategist for Zacks Investment Research. "We're recovering, but slowly."

Earnings don't always reflect the U.S. economy. Nearly half of all earnings for S&P 500 firms—the benchmark index used as a gauge for the direction of the U.S. economy—actually come from overseas. Some of that is due to exports, which benefit the U.S. economy because those goods are made here. But some of those foreign earnings are from overseas divisions of U.S.-based companies that build products in the countries they sell them in, with little benefit to the U.S. economy. So some portion of the earnings reported by big U.S. firms have little impact here in America.

Many smaller firms, meanwhile, aren't doing nearly as well as the big companies represented by the S&P 500. Small businesses account for the majority of new jobs in America, yet many of them still report precarious, recession-like conditions and a pessimistic outlook. That probably reflects the real job picture more accurately than the earnings of big corporations.

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Next year will be tougher. For many big firms, those big earnings gains will deflate like a punctured balloon when the comparisons get harder next year. Bank of America Merrill Lynch predicts that earnings growth will fall from a record high of 55 percent in the first 12 months following the recession (which economists believe ended around July 2009) to a meek 8 percent in the second year, which will end next summer. That's well below the average of 14 percent earnings growth in Year 2 of a recovery. If earnings growth is indeed that depressed next year, CEOs will be under intense pressure once again to cut costs. So hiring people now might mean laying them off in a few months.

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Demand is weak. Ultimately it takes increased spending and a growing economy to boost sales and give CEOs the confidence to expand their payrolls. And healthy demand for most goods and services just isn't there. After a minor uptick in spending earlier this year, consumers have shut down once again, with spending levels unchanged from a year ago. "Why hire if customers are not coming through the door?" van Dijk says.

Suppressed spending is a grim development, considering that "pent-up demand" usually leads shoppers back to the stores after a year or two of austerity. But not now. Consumer cutbacks are partly a circular response to the weak job market and the wobbly economy, but they're also part of a long-term shift in spending habits that were unsustainable to start with. By the time the recession hit in late 2007, Americans had record levels of debt that they're now slowly paying off. It could be several years more before household debt is back down to manageable levels that will allow Americans to spend without worry.

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Technology and foreign labor are cheaper than U.S. workers. One of the few things that companies are spending more money on is software and equipment. That's partly because prices are attractive and it's a buyer's market. But this is also part of the unmistakable trend in which microprocessors are displacing manpower. Computers don't need expensive health insurance or require a severance payment when put out to pasture. And so far companies have gotten good results by relying less on people and more on machines: Productivity growth is at record highs, which is one reason earnings have been strong.

The other grand trend everybody knows about is globalization, which allows firms of all stripes to substitute cheap overseas workers for more expensive American ones. As lamentable as the scarcity of jobs is, globalization and the technology revolution aren't going away. The good news is that rising productivity makes American companies more competitive, and a higher bar for hiring forces workers to get new skills so that they, too, become more competitive. That will pay dividends, eventually. "The reason that U.S. companies are so mean and lean is that they have not begun to hire in earnest yet," wrote Oppenheimer chief investment strategist Brian Belski in a recent research note. "Corporate America is in its best fundamental condition in decades, thereby providing the driving force for our economy's overall recovery in the next several years." It will just be a slow slog getting there.