Markets spent a fair bit of time this week worrying about what Federal Reserve boss Janet Yellen would say about interest rates.
In the end, they didn’t need to worry. Fed chief Yellen is following the well-worn path of her predecessors.
Don’t scare the horses. Don’t make any sudden moves. Make sure that Wall Street knows you’re on side, that the ‘Greenspan put’ – the implicit promise to step in and prop up asset prices – remains in place.
But it’s not Yellen that Wall Streeters need to worry about.
It’s Walmart.
Companies are having to compete for workers again
John Higgins at Capital Economics made a very interesting observation in a research note yesterday, that could have a big impact on the US stock market. It’s all about the natural level of unemployment.
You may be wondering – what’s the ‘natural level’? Put simply, the natural level of employment is the level of unemployment at which the supply and demand for labour balances out.
There are enough potential workers to go around without companies having to fight over them. But there aren’t so many that you’ve got legions of highly-skilled, good quality people standing in the dole queues going to waste. The ‘Goldilocks’ level if you like – not too hot, not too cold.
According to Higgins, since 1950, the US unemployment rate has dropped “well below” the Congressional Budget Office’s (CBO) estimate of its natural level on eight occasions. And Capital Economics expect this to happen again later this year.
Now clearly, estimating precisely the ‘correct’ rate for unemployment is not an exact science. But the CBO can’t be that bad at it. Because as Higgins points out, every time unemployment has dropped well below this estimated natural level, “there has been an increase in labour’s share of income”.
In other words – and as you’d expect – when employers start being forced to compete for scarce labour, the cost of labour goes up. And that means that a larger share of profits ends up going to staff, rather than shareholders.
And that’s bad news for stockmarkets.
You see, as Higgins points out, in the past, when labour’s share of income rises, companies have seen “relatively slow growth in profits. Indeed, even S&P 500 earnings per share have grown less rapidly than nominal GDP on average during these periods.”
And because growth in profits slows down, investors become less willing to pay ever-higher multiples for those profits. (In other words, the price/earnings (p/e) ratio on the market tends to fall.)
Now, maybe if p/e ratios were low today, that might not be such a problem. But they’re not. In the US, the long-term Shiller p/e (Cape) is sitting at some of the highest levels on record, outside of bubble periods such as 2000. And even if you adjust the Shiller p/e for changes in accounting standards and the like, says Higgins, “our amended Cape is still more than 25% above its average since 1950”.
The Walmart wages war
So when is this going to happen? It already is.
Walmart – America’s largest private-sector employer – said a week ago that it’s going to bump up starting wages for US staff to $9 an hour by April, and at least $10 an hour by next February. That implied a pay rise for nearly 40% of its 1.3 million staff.
Yes, there’s been pressure on companies to treat their staff better. And you can make the whole ‘Henry Ford’ argument about paying staff more so they can buy the stuff you sell.
But knowing Walmart, this is very much a commercial decision. Staff turnover is expensive. Poor customer service because your staff are demoralised and badly trained is expensive. So when you can’t get and keep good people at a certain price point, then you’re simply going to have to pay more, or you’ll be damaging your business.
And now it looks like a ‘wages war’ is very much under way. TJX Cos (which owns the TJ Maxx retail chain, among others) is also raising its starting wage to $9 an hour, from June. Ikea and Gap have already raised minimum hourly wages to similar levels.
Just to be clear, I think this is a good thing. So far, quantitative easing (QE) has largely benefited financial markets. You need to see that seep through to the ‘real’ economy and the average person, because otherwise there’s nothing ‘real’ to support those valuations.
And on a more cynical note – how do you expect to inflate away your debts, if there’s no sustainable basis for inflation?
What does this mean for your investments? It’s another reason to steer clear of the US stockmarket at these levels. It’s also a good reason to stick with the eurozone and Japan – QE is still at the asset price inflation stage of things, rather than the ‘real’ economy inflation stage.
Events in the US are going to be fascinating to watch – they may provide a very useful road map for what happens next.
As for the effect on inflation-sensitive bond markets – I take a look at that in the latest issue of MoneyWeek magazine, out tomorrow. If you’re not already a subscriber, you can get your first four issues free here.
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