Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services
- The US equity market, represented by the S&P 500 index, slipped 2.7% for the week ending February 24.
- Rising wages may negatively impact profit margins for some companies. However, the household saving rate is what matters for overall corporate profits.
This week, Home Depot reported its fourth quarter earnings and provided guidance for 2023. In their outlook for the coming year, Chief Executive Ted Decker noted that the company will invest $1 billion toward raising wages for its hourly employees, a move which is projected to negatively impact the firm’s profit margin. The stock swooned on the news.
The financial press picked up on this theme of higher labor costs impacting the outlook for corporate earnings. Lisa Abramowitz at Bloomberg noted that Home Depot is “an example of how stocks could suffer even if the U.S. economy muddles through. Margin pressure will keep being an issue.”
Mr. Decker further commented that while Home Depot must budget for higher wages, consumers have shifted spending away from goods toward services. This is the crux of the issue for goods-selling firms such as Home Depot. However, Home Depot’s lost sales as consumers shift to services has not disappeared. It has been reallocated across the economy and will appear in other sectors.
Higher labor costs may be bad for one firm, in this case Home Depot, but may not lead to lower corporate profits in the aggregate. Rising wages do not say anything about total corporate profits or profit margins - what matters for total profits is whether households spend or save their income.
If the overall household saving rate does not change as wages rise, higher wages will have no impact on total corporate profits or, likely, profit margins. If households decide to increase their saving rate, corporate profits will fall. Conversely, if the personal saving rate falls, then corporate profits will rise, all else equal.
Personal saving from disposable income skyrocketed in 2020 but has rapidly come down to earth. Last year, the personal saving rate fell below its long-term average of just over 5%. That has helped boost corporate profits.
Along with the falling personal saving rate, other drivers of total corporate profits such as investment and the US government fiscal position have led to historically high business profit margins over the last three years, per the chart below.
Source: Bloomberg, February 16, 2023
While profit margins are high for now, the trajectory of profits matters a great deal. The forces driving aggregate corporate profits are difficult to predict. That said, rising wages on their own will not pressure total profits, unless the household saving rate suddenly spikes.
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