The missing ingredient from the U.S. recovery has arrived — and that's bad news for stocks.
In a note to clients, a team at Credit Suisse Group AG led by Chief Global Equity Strategist Andrew Garthwaite highlighted a myriad of signs that a shift in power from capital to labor is well underway:
- Labor's share of national income is rising
- The Atlanta Fed's wage growth tracker is at a fresh cycle high
- Big states are hiking their minimum wages
- Wage growth in manufacturing is exceeding that of professional and business services, suggesting acute pressures at the lower end of the income spectrum
- The unemployment rate for those out of work for less than six months (the cohort with presumably the best ability to bargain for higher wages) remains near its lowest levels of this cycle
- The Federal Reserve's Beige Book indicated that wages were rising in almost every district in April
Most notably, despite a deceleration in nominal GDP growth, workers' pay gains have continued to edge higher:
Rising wages crimp corporate profitability, thereby weighing on the ability of S&P 500 companies to increase earnings. Credit Suisse found that for more than three decades, this gap between nominal GDP growth and wage growth has tended to correlate with the rate of profit growth. The S&P 500 has typically peaked roughly 12 to 18 months after profit margins, which tend to hit cycle highs 29 months after average hourly earnings trough.
Full employment — the point at which wages really start to accelerate — might still be a long way away, Garthwaite cautions. The U6 unemployment rate (which includes part-time employees who'd rather be working full-time, discouraged workers, and people who say they want a job but aren't looking for one) stands at 9.7 percent versus an average of 6.8 percent in the new millennium.
However, that won't prevent workers from steadily gaining ground on Corporate America.
"In our view it is the gap between nominal GDP and wage growth which is key, and which has tended to lead declines in profit margins. This gap has closed as nominal GDP has slowed but wage growth has not," the strategist concludes. "Second, total labor costs are rising as firms increase the number of workers, even if the pay growth of each worker is muted."
Credit Suisse remains neutral on global equities, citing not only the continued threat to U.S. profit margins, abundant political risk, and persistently sluggish global economic growth.