What's Good for Workers Is Terrible for Investors
Last week the Washington Center for Equitable Growth reported that 2015 was the best year for real income growth for the bottom 99 percent of income earners since 1998, as the impact of a tightening labor market and deflationary forces from abroad flowed through to workers. Wage data from the first-quarter GDP report suggests that 2016 will continue this trend: Wages and salary accruals as a percentage of GDP reached a seven-year high, and stands higher than at any point during the credit boom years of 2005-6.
What's encouraging for workers is that in both of the last two economic cycles, the wage share of GDP peaked as the economy was tipping into recession, suggesting that this outperformance should continue for as long as this economic expansion does. More encouragingly, the last two cycles ended because of a combination of too much business or housing investment, too much leverage, and overly tight monetary policy. There's still no reason to be concerned about any of those three in this cycle.
Surprisingly, despite a tightening labor market, wage growth that has exceeded GDP growth for several quarters, and firming core inflation, treasury yields continue to sink lower, caught up in the same trend of lower government bond yields around the world.
These two trends -- wage growth in excess of GDP growth, and falling interest rates -- create a conundrum for investors. What economic and financial market path should investors be rooting for?
If the expansion continues, wage growth outpacing GDP growth might mean that corporate profit growth may continue to disappoint, as it has in recent years. Corporate profits are essentially unchanged over the past four years, and over that time corporate profits as a percentage of GDP have fallen from 10.8 percent to 9.3 percent.
And unless the laws of economics have changed, several more quarters of above-trend wage growth will probably feed into inflation, and lead to more interest rate hikes. With the 10-year Treasury rate currently under 1.5 percent, expectations for even a modest tightening of interest rates could be a rude awakening for the fixed-income market.
The other scenario, in which the expansion is nearing its end, is even worse for investors. Should that occur, corporate profits and profit margins would probably fall significantly, erasing much of the equity gains of this cycle. With Treasury yields already so low and "safety" stocks like those in the consumer staples and utilities sectors already so expensive on a price-to-earnings basis, a diversified stocks-and-bonds portfolio might not provide the protection it did when interest rates were higher.
With the benefit of hindsight, we might look back at 2006 and see that households and workers were in a no-win situation. Either interest rates were going to keep going up, burdening over-leveraged households and those with adjustable-rate mortgages, or the housing sector was going to roll over and take the economy with it. For middle-class workers with a job and a house but not much in the way of financial holdings, all outcomes were bad.
As we enter the second half of 2016, we might have hit the same point for investors. A continued expansion probably means some combination of above-trend wage growth, below-trend profit growth, and possibly higher inflation and interest rates. An end to the expansion means recession. It's an economy for all workers to cheer … except the ones working on Wall Street.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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