It’s not the Fed, and it’s not interest rates. It’s not Obamacare or Obama himself. It is not the national debt. And it’s not China either.
I can summarize the fundamental problem facing the US economy in a chart:
The median American family earns less money than 15 years ago. Data for 2015 is not yet available, of course. But the median family income in 2014 is 6.5% lower than it was in 2007. It is 7.2% lower than 1999 levels.
Now, you could certainly point out that 1999 and 2007 were the high points of two important economic cycles. In fact, they were bubbles and one would expect revenues to be higher. But the trend is down, and 2007 revenues were lower than 1999.
Why is this, you ask? Is China and its rising standard of living taking away American manufacturing jobs? That’s probably part of it.
But again, I can show you the main reason why family incomes are falling in a graph:
In a nutshell, wages are falling while corporate profits are rising. This chart shows the disparity as a percentage of total US GDP. Since the mid-1970s, wages as a percentage of GDP have fallen by 7%, while corporate profits have increased by 7%. It’s a pretty compelling relationship.
There is no doubt that this has been something of a golden age for corporate profits. They are at record levels and have been for several years. Business cash balances are also at record highs. This is an important reason why equities have performed so well.
As an investor, I like that. I like the companies I invest in (and recommend) to have plenty of cash. This allows them to increase earnings per share with share buybacks and pay larger dividends (both of which are also at record highs).
But it seems to me that this golden age of corporate profits has a cost, namely the standard of living of the American middle class. The US economy is 70% domestic spending. It is fueled by middle-class spending. Falling middle-class incomes are worrisome…
CEO vs Employees
The most visible income disparity these days is between corporate executives and “regular” employees. The average CEO of an S&P 500 company earns 204 times the median salary of a regular employee. So if the median salary is $50,000 per year, the CEO earns $10.2 million.
It’s just a huge difference.
CEOs are responsible for running large companies. Obviously not an easy job. If they fail, they can literally threaten the whole company. Worldcom, Tyco, MF Global, JC Penney – there’s a long list of companies that have failed, or nearly failed, due to poor leadership.
Funny thing, though – often, even when companies fail, many employees lose their jobs, while the CEO flies away under a multi-million dollar golden parachute. Like the last CEO of McDonald’s: he held the position less than three years. A month after he was fired in January 2015, McDonald’s decided to keep him on as a consultant for the rest of the year. His salary ? Another $3 million. In addition to the $27 million he “earned” by failing.
Target CEO Gregg Steinhafel has been fired after 40 million credit and debit card numbers were stolen. He received a severance package of $15.9 million.
These are just a few examples. But the fact is, it’s pretty unlikely that you or I will be paid so generously for failing so badly. What makes these guys so special?
My feeling is that the CEO justifies the existence and compensation of the board. Board members are well paid. The average board member of an S&P 500 company earns $250,000 a year for working 250 to 300 hours. It’s about $833 an hour — just a little better than minimum wage.
And as director of corporate governance researcher BHJ Partners Paul Hodgson said Bloomberg: “These directors are paid so well that I never see them questioning management about anything because it’s a gig they would hate to lose.”
Of course, CEOs and boards of directors are the most visible aspects of the corporate earnings picture. But their compensation is just a drop in the bucket of an S&P 500 company’s total earnings…
Companies are people too!
Consolidation through mergers and acquisitions makes larger companies much more powerful. The Harvard Business Review recently noted:
Just 10% of public companies accounted for 80% of profits generated by all such companies in 2013. In North America, public companies with annual sales of $10 billion or more captured 70% of profits in 2013, compared to 55% in 1990. …
Part of the reason for the consolidation of profits in large companies is mergers and acquisitions.
What happens when companies merge? People are getting fired, sometimes in the thousands. When Warren Buffett teamed up with Brazil’s 3G Capital to buy Heinz in 2013 for $23 billion, 600 workers were axed. Then Warren Buffett got Heinz to merge with Kraft, and another 2,500 workers were laid off.
Buffett has earned around $10 billion in three years. More than 3,000 workers have been made redundant. And no real value has been added to the companies themselves.
It may be time to think about changing the way we review mergers and acquisitions. After all, despite what the Supreme Courts say, corporations are not people. And they shouldn’t have the same rights and interests as people.
Till next time,
Till next time,
A 21-year veteran of newsletters, Britain’s Ryle is the editor-in-chief of Wealth advice income equity newsletter, focused on dividend growth stocks and high quality REITs. The Briton also manages the Real Income Trader advisory service, where its readers receive regular cash payments using a low-risk covered call strategy. He is also editor of the Wealth Daily e-newsletter. To find out more about Brittany, click here.
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