The consumer's sudden turn toward radical restraint is inflicting heavy damage on a second sector that could be called "anything you normally like to do or buy but can put off." In fact, this group saw the second-biggest drop in dollar earnings behind the financials. In the Fortune 500 it's composed of 101 companies in a category called consumer cyclicals. It includes purveyors of goods and services big and small, homebuilders like Centex and D.R. Horton, retailers from Lowe's to Nordstrom, automakers GM and Ford, hotel operators like Starwood, and gaming giant MGM Mirage.
"These are things that you can either do without for a while or don't need to replace right away," says Dirk van Dijk of Zacks Investment Research, a firm that compiles earnings forecasts from analysts. Americans are saying, "I'll cook at home instead of going to Olive Garden," or "I won't buy a new car until I'm sure I'll keep my job," or "We'll delay that vacation to Bermuda until next year."
More than any other sector, the consumer cyclicals suffered from a severe downdraft in sales. "It's a top-line story," says Ken Matheny, an economist with the research firm Macroeconomic Advisers. The force that made the category so profitable from 2002 to 2006 totally reversed. As volumes declined, so did margins. Hence, the operating leverage that increased profit for every toy or refrigerator sold as sales rose in the good years turned negative. The results are daunting: From 2006 to 2008 the cyclicals careened from total profits of $38.3 billion to losses of $42.3 billion. Hardest hit were automakers General Motors (-$30.9 billion) and Ford (-$14.7 billion). Hotels and casinos, publishing, and homebuilders all swung from big profits in 2006 to steep losses. The stay-at-home consumer also left airlines in the lurch: Carriers went from a gain of $15 billion in 2006 to a deficit of $19 billion last year.
Only two sectors posted profit increases over 2006. Health care, a spending item most consumers won't do without, showed a tiny increase, to $69.1 billion. Among the stars were drugmakers, a group that typically shines in a recession, including Johnson & Johnson ($12.9 billion), Merck ($7.8 billion), and Abbott Labs ($4.9 billion). Technology also showed a minuscule gain, to $92.8 billion. In part, that's because tech companies never participated in the earnings bubble. Their profits ballooned in the late 1990s as companies gorged on fiber-optic networks, routers, and workstations. Since then they've been mostly flat. So while they didn't spike in the boom, they've remained stable in the bust. Clearly, tech customers aren't rushing to expand as they did in the '90s, but they're handing the tech giants a steady flow of business updating and servicing their systems. Microsoft ($17.7 billion), Cisco ($8 billion), Oracle ($5.5 billion), and Apple ($4.8 billion) stand tall as some of the most reliable profitmakers in the Fortune 500.
To understand the profits disaster, it's important to review the forces that created the bubble. From 2003 to 2006 the economy provided a perfect environment for earnings. A major contributor was a strong rise in revenue growth. It was driven by two factors. The first was a powerful surge in volume - unit sales of everything from cars to toys. The driver was buoyant consumer demand that raised GDP an average of 3.3% a year. The second force was the tail wind from rising prices. In that period the dollar fell sharply, forcing foreign companies to charge more for their products imported to the U.S. That gave U.S. companies plenty of space to raise their prices. In that period Fortune 500 revenues jumped 9% a year.
The bounty didn't stop there. Labor costs, which account for two-thirds of all corporate expenses, barely budged during the glory days. Faced with a pro-business administration, unions didn't push aggressively for wage increases. Workers were generally pleased with the ample job opportunities, while the rising values of their homes and investments gave them a strong feeling of security. Wages rose modestly. And the mild increase in pay per hour was totally offset by a potent surge in productivity. Since U.S. companies had loaded up on high-tech capital equipment in the 1990s, they were able to harness those workstations and software programs to dramatically reduce the time needed to assemble a car or process a mortgage application. That's the definition of productivity: the hours required to produce a good or service. The fall in hours canceled the increase in wages.
Hence, the dollars required to make a single airplane part or ton of packaging, a crucial measure called unit labor costs, didn't increase from 2003 to 2006. It also helped that volumes were rising, so that more and more goods ran through the highly productive plants with the same lean workforces. With prices per unit rising and labor costs staying flat, the result was an explosion in margins, or profit per appliance or home sold. In the peak profit year of 2006, the average margin of Fortune 500 companies hit an all-time record of nearly 8%. "All of the increases in productivity went right to the bottom line," says Mark Zandi, chief economist for Moody's Economy.com. "We'll never see another profit period like it."
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