The Independent Market Observer

Wall Street Vs. Main Street: Is Walmart Caught in the Middle?

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Oct 15, 2015 2:47:00 PM

and tagged In the News

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wall streetOne of yesterday’s big news stories was the surprise announcement by Walmart that, instead of growing by 4 percent (as expected), earnings per share were expected to decline by between 6 percent and 12 percent in fiscal year 2017. Shares, of course, dropped substantially, and the market as a whole took note. Lower earnings are bad, right? For the company, and quite possibly for the market, this is certainly true. But is it bad for the economy and the country? I don’t think so.

In fact, when I was asked in an interview for some good news from the Walmart story, it was actually a pretty easy question to answer. I think Walmart's earnings news speaks to where we are now, as both an economy and a stock market.

The zero-sum game

One of the major drivers for the market’s advance has been rising corporate earnings: Companies sell a certain amount and pay out to their suppliers, employees, and taxes; the remainder is called earnings. But this is a zero-sum game with respect to employees. If employees make less, the company makes more, and this is exactly what has been happening since the crisis. Companies have been growing sales much faster than wages—and keeping the difference.

You’ve probably noticed that this has been great for the stock market (Wall Street) but not so good for the employees (Main Street). Even as companies have been making lots of money, the problem for the economy as a whole has been lack of wage growth. Again, largely a zero-sum game.

But as I have been saying in my talks around the country, this has started to change over the past several months as the job market has tightened:

  • Unemployment is down to normalized levels.
  • Initial unemployment claims are at all-time lows as a percentage of the labor force.
  • Wage growth, although still low, is rising.

It looks as if we’re getting close to a tipping point where labor will have more bargaining power.

Higher wages for hourly workers

Walmart, Target, and McDonald's have all announced plans to give higher wages to hourly workers. I suspect these companies were not motivated by altruism but, rather, by a need to attract and retain good workers. We are now ready to start on the reverse of the past five years: wages increasing at the expense of profits. The Walmart announcement, which specified higher wage costs as a major reason for the earnings decline, is the first step in this change.

If this trend continues—and I suspect it will—it will be a contributory factor in the slowing earnings growth we talked about the other day. Even if all the other positive trends for companies continue, the normalization of the labor market will certainly normalize wage growth eventually, to the detriment of earnings growth. There is, however, quite possibly an offsetting positive factor here as well: Higher wages will result in faster economic growth and, therefore, faster revenue growth.

The corporate perspective

So, for companies, the news is not all bad. Think about it this way: When companies keep the money, they save it or pay it out to relatively wealthy shareholders (through dividends or buybacks). Either way, the money is not necessarily being spent and not contributing to growth. If, on the other hand, the money goes to hourly workers—who have been increasingly stretched financially—these workers will spend the money immediately, which will then drive higher growth.

Beginning of an economic shift?

This trend is in its early days, but there are signs it is taking root. Along with low gas prices, higher wages arguably have been behind the rapid growth in car sales. There are also signs that the potential positive effects for companies and the stock market are real, for example, in the strong performance of consumer stocks.

This will not, except in special cases like Walmart, be a game changer for individual companies. But it will act as a shift in the economic environment, just as it has in the past five years. Expect to see a continuing shift away from profits and toward wages—which should help alleviate the slow growth we have experienced, to the benefit of the economy and the country as a whole.

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