The Importance of Investment
Last week the Department of Commerce announced that its advance estimate of GDP growth for the third quarter was revised upward from a 2.0% annual rate to 2.5%. Along with the upward revision in GDP growth, the Department released its first estimate of corporate profits for the third quarter. Corporate profits before taxes increased at an 11.5% annual rate in the third quarter and stood 27.8% above the level of a year ago. Since reaching a trough in the fourth quarter of 2008, corporate profits have increased by more than 66% and now stand at a new all-time peak. Since the end of 2009, corporate profits are up 17%. This growth has important implications for commercial real estate.
While some may decry the growth in profits in an environment where the unemployment rate remains stubbornly high at 9.6%, the increase in profits is a necessary condition for further and faster employment growth. Businesses are not going to hire new employees if they do not have the money and they must see some potential for profit growth or there is no reason to take risks and add to payrolls.
In fact, history shows that there is a very strong relationship between corporate profits and employment.
I have borrowed the chart below from Mark Zandi of Moody’s Analytics. The chart shows the change from a year ago in corporate profits and payroll employment. The trick to this chart is the 3-quarter lag applied to employment growth. The way to read this is: employment growth in the current quarter is related to profit growth three quarters earlier. As the chart shows, the relationship is very strong, with profit growth inevitably leading to employment growth. The surge in profits over the first three quarter of this year strongly suggests that employment growth is more likely to accelerate than slow. Many analysts anticipate that employment growth will remain sluggish in 2011. The history of the relationship between profits and employment suggests that employment growth will be strong in the coming year.
Of course, employment growth will boost commercial real estate. While we remain cautiously optimistic about national real estate markets, this analysis suggests that if there is a surprise in the coming year it is likely to be a positive one with employment growth and therefore real estate markets stronger than expected.
Ken McCarthy
Senior Economist, Senior Managing Director, Research
Cushman & Wakefield
