Last week, I looked at how corporate profit margins had hit a seemingly permanently higher plateau.
According to Jeremy Grantham of US wealth manager GMO, a combination of monopoly power, globalisation and low interest rate policies have conspired to drive margins up over the past 20 years or so.
So today I want to look in more detail at what could prove the biggest threat to corporate profits in the US: rising wages.
The US jobs boom has to lead to higher wages before too much longer
Last week, US unemployment data revealed that more than 200,000 jobs were added by the US economy in April. The unemployment rate also fell to 4.4%, the lowest since before the financial crisis.
Meanwhile, underemployment – a measure of people who either have no work, or have part-time work but would like to be working more – fell to its lowest since November 2007.
And yet wage pressure has remained fairly subdued. Wages were only up by 2.5% year-on-year. Given the strength of the current job market, that doesn’t look as though it can last. And digging deeper into the employment data of recent months suggests that it probably won’t.
For example, take the “Job Openings & Labor Turnover Survey” (JOLTS) report that also comes out every month. The most interesting figure to focus on in this data are the figures for “voluntary quits” – people walking out of their jobs.
As David Rosenberg of Gluskin Sheff points out, this figure rose to 3,116,000 in March, “the third highest total this cycle” (ie since the financial crash). Why is this good news (for wages, at least)? Because people generally only voluntarily leave their job for one reason – they’ve found a better one elsewhere.
In turn, that suggests that wage pressure will increase. If your employees are confident enough of getting a better offer to walk out of the door, then you need to start offering more money and better conditions to retain them. That seems logical, and looking at historical data, “quits” are indeed a strong leading indicator of wage growth.
Meanwhile, other indicators are pointing to higher wages too. The number of workers available per job has fallen to its lowest level in the current economic cycle too. There are roughly two workers for every job, compared to a staggering nine at the very peak of the post-crash recession. As one analyst tells Bloomberg, at this point in the economic cycle “anyone who’s inclined to be hired is already hired and any incremental hiring has to come at a higher cost”.
Higher wages aren’t good news for everyone
Looking at a few specifics, American Airlines recently increased wages for crew members (hurting the share price, naturally). Pilots got an average raise of 8% while flight staff got 5%. Those pay rises came despite current contracts not running out until at least 2019.
Meanwhile, poultry giant Tyson Foods said that it might have to raise wages for all of its staff, having already boosted base wages by 3%–3.5% in November. One HR executive warned that “the pool of available labour is shrinking”.
Now, let’s be clear – higher wages are a good thing, given that central banks and the like have been trying to generate inflation for almost the last decade now. Higher wages mean more spending, which means companies expand, which means more jobs and higher wages and so on.
Trouble is, repression of wages has been one of the big drivers of corporate profitability in recent years. If wages rise, that might be the very thing to dent the surprisingly large profit margins we’ve seen over the last two decades or so. And of course, higher wages will also eventually mean higher price inflation too – though that might take a little longer to come through.
It’s interesting to note that this vexed question of rising labour costs is already having an effect in the stockmarket. As Lu Wang points out on Bloomberg, since the start of this year, companies in the US with low labour costs (relative to revenue) have started to outperform those with high labour costs, amid concerns that rising wages will squeeze profit margins.
So what does this mean for markets? Rosenberg is concerned that the US Federal Reserve, rattled by potential wage inflation, will end up being overly aggressive, and that will hammer the recovery. “There are few things that can bring an end to an expansion as quickly as an aggressive Fed.”
Given Janet Yellen’s record of relative timidity – and the fact that she’s the heir to Alan Greenspan’s intellectual framework – it might take a bit of time to unfold. But eventually, higher rates, says Albert Edwards of Société Générale, “will blow the US corporate sector and economy sky high.”
That’s strong stuff. But wage inflation is definitely the figure to watch this year.
PS By the way, you should watch Question Time tonight (BBC1 at 10:45 pm – half an hour later in Northern Ireland), even if you normally skip it (I realise it can be bad for the blood pressure!). My colleague, Merryn Somerset Webb – MoneyWeek’s editor-in-chief – is on this week. If you enjoy Merryn’s columns, you’ll definitely enjoy watching her spar with the rest of the panel on the big topics of the day.