via National Post
By Jacqueline Thorpe
We have commented that the one thing the U.S. economy has going for it that many others don’t is its ability to churn out strong productivity growth — even in the face of a brutal recession. In the first quarter, the United States achieved productivity growth, or output per hour per worker, of an annualized 1.6%, as companies slashed costs and jobs in reaction to the downturn. Painful for sure, but essential to lay the groundwork for recovery.
In report on Thursday, Barclays Capital says that productivity growth is the silver lining of this recession that will lead to wider profit margins and help sustain the recovery in equities.
Tim Bond, head of global asset allocation at Barclays Capital, says the 4.8 million Americans that have lost their jobs in this recession are unlikely to be hired back in one fell swoop. As is usually the case, employment will lag output, resulting in the typical early-cycle phenomena of rising productivity growth and falling unit labour costs.
While many analysts say the U.S. recovery will be weak, Mr. Bond argues that given the epic scale of inventory liquidation, the rise in output could be quite smart. Productivity will increase even more and labour costs will fall. He forecasts annualized productivity could rise as much as 2% in the first few quarters of recovery.
“Since unit labour costs are the main component of business profit margins, the outlook is strongly biased towards an unusually extensive widening of profit margins,” Mr. Bond said in a note. “The early cycle revival in profits should therefore be stronger than is typically the case.”
On the basis of consensus earnings forecasts, the S&P 500 currently trades at a 14.5 12-month forward PE ratio (using a four-quarter moving sum of earnings).
However if he revises earnings forecasts to take into account stronger productivity growth and wider profit margins, the forward PE ratio falls to 12.5, from which he infers “the market may have further immediate upside of 15-20%, as the more benign outlook for profits begins to be discounted.”