Albert Edwards Explains Why He Wasn’t Wrong & Delivers The “Bottom Line” For US Companies

So remember what we said earlier this month about what you should be watching for in each successive NFP report?

No? That’s ok. We don’t remember either (years of alcohol abuse impairs the memory).

But while perusing Albert Edwards’ latest note this morning, we thought his argument sounded familiar so do you know what we did? Well, we’ll tell you: we went back and we looked at our last NFP post, that’s what we did. And here’s what we said:

If you were wondering what to watch for in today’s “all-important” (just forget collapsing commodities) NFP report, the answer is simple if you put any stock in recent history: the AHE print.

“Of last six employment reports, four spurred moves that were driven primarily by the average hourly earnings component rather than nonfarm payrolls,” Bloomberg writes, adding that “the reaction to most recent report was driven by unemployment rate.”

Right. And then we went back and we looked at something else we wrote recently that we remembered a little better. Specifically, this post, “What Does An Overheating Labor Market Mean For Stocks? I’m Glad You Asked,” in which we said the following:

Ok, so the labor market is overheating.

We know that. For the Fed, the question is whether to act on that with “preemptive” tightening strikes, or whether to wait on realized inflation to move sustainably above target. The market is betting on the former.

Obviously, an overheating labor market presages upward pressure on wages. It’s supply and demand. Shit like that.

Well… ummm… that should crimp corporate margins, right? Probably.

I mean better tech, the rise of the machines, and lower taxes should help, but we may be at “peak that stuff” – so to speak. So if we are at “peak that stuff,” then that means wage pressure will be a headwind to profitability. That, in turn, would (or I guess “should” is better, because God knows nothing has stopped this market yet) be a headwind for equities.

Well, as alluded to above, Albert Edwards has some thoughts on wage inflation. Specifically, he can’t understand why it isn’t comin’ in hotter than it is:

I believed that a tight labour market would prompt an aggressive reaction from ‘the workers’ to maintain the previous 1½-2% rate of real wage inflation they had enjoyed and got used to through 2015 and 1H 2016. Hence I expected nominal wage inflation would roar upwards in 1Q this year. How wrong I was!

Yes, “how wrong” I/we was/were.

Or was “we”?

Here are a few excerpts that suggest the narrative we outlined in the second post linked above probably still holds…

Via SocGen

Talking about wrong, I have to put my hands up. I have been expecting US wage inflation to roar ahead over the past three months to well above 3%, yet every data release has surprised on the downside. Wage inflation, as measured by average hourly earnings, has actually leveled off at close to 2½% while wage inflation for ‘the workers’ is actually slowing (see chart below)! Strictly speaking, ‘the workers’ are defined (by the BLS) as those who are not primarily employed to direct, supervise, or plan the work of others. Hey, that’s me!

AE1

As headline CPI inflation surged this past six months, rapid real wage growth turned into real wage stagnation (see chart above). I believed that a tight labour market would prompt an aggressive reaction from ‘the workers’ to maintain the previous 1½-2% rate of real wage inflation they had enjoyed and got used to through 2015 and 1H 2016. Hence I expected nominal wage inflation would roar upwards in 1Q this year. How wrong I was!

Although average hourly earnings is only one of many measures of wage inflation in the US, it the most closely watched by the markets. And although this measure of wages has failed to accelerate over the past six months or so, other measures produced by the US Bureau of Labor Statistics (BLS) show continued rapid acceleration, including the Employment Cost Index (ECI) version of wage inflation. Wage and Salaries jumped from a 0.5% rise in 4Q to rise by 0.8% in 1Q 2017 the fastest quarterly rise since 2007. On a yoy basis, this measure of wage inflation still showed a 45 degree upward trajectory into 1Q 2017 (see left-hand chart below). Adding benefits to wages and salaries, total compensation also rose by 2½%.

AE2

Even this ECI measure of wage inflation may be an understatement of the actual acceleration. When calculating productivity and unit labour cost growth, the BLS estimate non-farm businesses saw their workers compensation jump from the 3% average rate seen in 2016 to just shy of 4% yoy in 1Q 2017 link. Together with sluggish 1% productivity growth, this means that unit labour costs are rising by almost 3% yoy, well in advance of the rate by which corporates are able to raise their output prices (see right-hand chart above).

The bottom line is that US corporate margins are suffering a savage squeeze and have been for some time. What then do I make of the heady 1Q company reporting round? Not much.

 

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