The S&P 500 enjoyed another record close on Friday night.
The market is now sitting at 2,651. That’s pretty impressive – a near-20% gain – given that it started the year at just above 2,235.
(Yes, I know that bitcoin has been better. Bitcoin has been better than everything. But as a wise person once nearly wrote: “man shall not live by bitcoin articles alone”.)
What made investors so cheerful? And what – if anything – could knock them off their stride?
The golden combination – decent jobs growth and weak pay rises
The US non-farm payrolls figure is arguably the most important economic data release in the world right now.
It shows each month how many jobs have been added to the US economy and what the unemployment rate is. It’s called the “non-farm” payrolls figure because it excludes agricultural employment. But as agriculture now accounts for a minuscule proportion of US employment, it’s effectively the national unemployment rate.
The figure sees huge revisions from month to month. The amount of weight placed on it by markets, is frankly, silly. Yet in the absence of anything better, it tends to set the tone for the month’s trading.
That’s because it’s seen as informing what the US central bank, the Federal Reserve, is likely to do next.
And on Friday, it came out with the golden combination.
Payrolls rose by 228,000. That’s a nice healthy jobs number, and a little better than expected. It shows the economy is still growing and there’s no obvious need to worry on that score. The unemployment rate, meanwhile, was stuck at 4.1%.
(You can spend hours delving into the details to try to find a more bearish interpretation of the figures – and sometimes that’s worth doing – but the headline figure is certainly healthy enough.)
And yet, wage growth remained weak, rising by just 2.5% year-on-year. The market loves that – for as long as wage growth remains weak, the Fed won’t be afraid of inflation. And while the Fed is unafraid of inflation, that means interest rates won’t go up any more rapidly than the market currently believes.
So while the market expects interest rates to go up by a quarter point this week when the Fed next meets, it’s not overly worried about monetary policy getting a lot tighter any time soon.
In turn, that means nothing should upset the current applecart, whereby markets enjoy the availability of relatively cheap money against a backdrop of gentle, steady growth, and unthreatening inflation.
It’s the same Goldilocks scenario that we’ve been locked in for years now.
The question is: will it ever change? What, if anything, could make inflation take off?
This is nothing to do with robots or ageing – it’s just about time
Plenty of commentators worry that automation and robotic augmentation will keep people out of work and suppress wages. I struggle with this.
I see automation as being similar to arguments about demographics. It’s such a long-term thing, and so dependent on small changes to the variables involved, that you cannot rely on the forecasts in any way that makes them useful for any feasible investment horizon.
Sure, you might get an idea of the general direction things are going in, and the threats and opportunities that might arise from that. But these forecasts are designed to be reacted to. A report might predict that birth rates will turn negative – therefore, governments alter immigration policy, or fund free childcare, and alter the behaviour of their populations.
My point is – you can’t use these forecasts as the basis of your portfolio strategy. There are too many “unknown unknowns”. Whatever is suppressing wages right now, it’s not because human beings are being replaced by robots. Companies aren’t yet investing enough for that to be the case.
The reality is that, as with many aspects of this recovery, the problem may be that we are too impatient. We see the logic of inflation rising, and so we expect it to happen tomorrow. That’s not how these things work.
Instead, things won’t move for a long time. And then when they do move, they’ll start to move fast. And that time may be coming.
As Capital Economics points out, the US labour market is getting tighter all the time. Small businesses are saying that jobs are now harder to fill than at any time since the early 2000s.
“Anecdotal evidence suggests that the labour market is getting very tight, too. Six of the Fed’s twelve branches reported tight labour market conditions or work shortages in the latest Beige book” report, notes Michael Pearce of Capital Economics.
Meanwhile, “spending on non-wage benefits has accelerated”. In other words, workers might not be seeing their per-hour pay rise, but their conditions are getting better, which also means that the cost of employment is picking up.
Equally, certain sectors are seeing faster wage inflation than others. In the leisure and hospitality industry, wages are now rising at around 3.5% a year. As a result, Capital Economics reckons that inflation will rise faster than expected, and that the Fed will hike rates four times next year. That compares to the market’s expectation for two hikes (and the Fed’s predictions of three).
In short, unless we get a recession to cool things off, then chances are the labour market will continue to tighten, wage growth will take off and the Fed will have to hike rates faster than expected.
Or – what I think is rather more likely – it’ll find a good excuse to keep hiking them at a steady pace, one which is quite some way “behind the curve”. In turn, that’ll be good news for assets that like inflation. Gold is one of them, commodities are another. All of those currently happen to be unusually cheap versus stocks and bonds in general.