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Despite plodding economy, some profit

Cost-cutting, flat pay lift corporate world’s fortunes

Things look different to traders on Wall Street and people on Main Street: Even though economic growth lags and the unemployment rate is high, stock have been on a tear.

Richard Drew/Associated Press/File 2013

Things look different to traders on Wall Street and people on Main Street: Even though economic growth lags and the unemployment rate is high, stock have been on a tear.

WASHINGTON — Look at the US economy and you’ll notice an unusual disconnect.

It’s being slowed by a tight job market, scant pay raises, and weak business investment. Yet corporate profits and stock prices are reaching record highs. What gives?

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For starters, weak job growth has held down pay. And since the recession struck six years ago, businesses have been relentless in cutting costs. They have also stockpiled cash rather than invest in new products or business lines. And they have been earning larger chunks of their profits overseas.

All of which is a recipe for solid profits but tepid economic growth. The economy grew at a meager annual rate of 1.8 percent in the first half of 2013. The unemployment rate is 7.2 percent, far above the 5 to 6 percent considered healthy.

Even so, corporate profits equaled 12.5 percent of the economy in the April-June quarter, just below a 60-year high reached two years ago. Profits of Standard & Poor’s 500 index companies have nearly doubled since June 2009.

Burger King’s sales fell last quarter as competition intensified. Yet its earnings surged because it cut expenses and enjoyed growth overseas.

‘‘Corporations have more market power than workers have and have kept wage growth to subdued levels,’’ says Dean Maki, an economist at Barclays. ‘‘That’s left more for corporate profits.’’

Those solid earnings have helped boost stock prices. So has the Federal Reserve’s drive to keep long-term interest rates near record lows: Lower bond yields have led investors to shift money out of bonds and into stocks, boosting stock prices. The Dow Jones average is up nearly 20 percent this year.

Here are factors economists cite for the gap between healthy profits and subpar growth:

Flat pay

Wages and salaries equaled 42.6 percent of the economy in the April-June quarter, near a record low set in 2011. More than 8.5 million jobs were lost in the recession and its aftermath, forcing workforces to be leaner and more productive. Corporate revenue rose as the economy recovered.

But workers haven’t benefited much. With unemployment high, they’ve had little leverage.

‘‘We’ve just had a very lopsided economic recovery,’’ says Ethan Harris, an economist at Bank of America Merrill Lynch.

Smaller paychecks have deprived Americans of money to spend. In the 30 years before the recession, consumer spending grew an average of 3.4 percent a year. Since 2010, just after the recovery began, it’s risen just 2.2 percent a year.

Stock market gains have boosted total household wealth. But they haven’t enriched most Americans. The wealthiest 10 percent of households own about 80 percent of stocks.

Cost-cutting

This week, Kellogg said it would cut 7 percent of its workforce, or 2,200 jobs, by 2017 — part of a ‘‘global efficiency and effectiveness program.’’ Though Kellogg’s sales were flat in the July-September quarter, it squeezed out 2.5 percent more net income. A key factor: It cut administrative and borrowing costs. Its shares have risen 15 percent in the past year.

FedEx is cutting jobs, too. Its quarterly revenue rose just 2 percent, but earnings grew 7 percent. The company has cut maintenance costs by replacing older aircraft. But the new planes don’t expand FedEx’s fleet. So the economy doesn’t stand to benefit as much.

Cash hoarding

Higher profits help the economy if corporations plow them back into plants, equipment, and other projects. That hasn’t happened. ‘‘Corporations have been extremely cautious in their spending in this recovery,’’ said Maki. Business spending on big-ticket items has remained about one-third below the average in previous recoveries, Harris estimates.

Instead, companies have stockpiled a record $1.8 trillion in cash, according to the Federal Reserve, up nearly 10 percent since the recession ended. And thanks to the Fed’s drive to keep rates low, companies have been able to borrow cheaply and replace higher-cost debt. All that has bolstered corporate finances and helped lift stock prices.

Improved finances are ‘‘great for the company and its stock price, but from the point of view of the broader economy, you’d prefer they use the money to hire more workers and invest in more projects,’’ Harris says.

Economists say chronic budget fights in Washington and Europe’s financial crisis have left executives uncertain about the economy and reluctant to commit to big projects. So have the uncertain consequences of the Obama health care law, said Mark Vitner, an economist at Wells Fargo Securities.

Globalization

International competition has lowered wages as a share of the economy in most developed countries, according to the Organization of Economic Cooperation and Development. About one-tenth of the decline is due to competition from lower-wage countries, it says.

And big US companies earn a larger share of profits overseas than in previous decades. That means their profits and stock prices can grow even when US growth is weak.

Nearly half of sales recorded by companies in the S&P 500 index are from abroad. In 2003, the figure was 41.8 percent.

Aswath Damodaran, a professor of finance at New York University, says the trend is a global one. Many Indian companies have fared well even as India’s economy has slowed. The French luxury goods company LVMH did only a tenth of its sales in France in 2013.

‘‘It used to be that US companies lived off the US economy and French stocks lived off the French economy,’’ Damodaran said. ‘‘Now, stock markets are more reflections of the global economy.’’

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