Contrary Investor
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Place Your Wagers...At the risk of beating a dead horse, we again suggest that wage gains are a very serious indicator that is clearly taking a back seat to the headline payroll employment obsession of the moment. From our perspective, watching wages and salaries is, in fact, more important than the headcount numbers. And we suggest the rate of change in wages has taken on heightened importance over the last month or so with the obvious rise in the general level of interest rates, crude kissing $40 per barrel, and what has become the recent continued barrage of consumer product price hike announcements. We hope it's helpful to quickly review the following charts. The data is through the first quarter of this year. You'll remember that payroll employment gains over the last two months have come almost completely from the service sector. As of the end of 1Q 2004, the year over year change in service sector wages was the lowest in a quarter century at least. Depending on changes during any one month for both data points of CPI and wages, the service sector is about to, if it hasn't already started to, experience negative annual real wage growth (a growth rate below that of the rate of inflation). Unless the annual rate of change in service sector wages makes an about face in trajectory somewhere very soon, and we mean very soon, the ultimate "social short squeeze" is about to begin.
As interest rates, energy prices, and prices of household goods move higher at an annual rate exceeding wage growth, and absent any further personal tax cuts ahead, discretionary consumer spending is going to get squeezed. And squeezed in a big way. Higher energy prices, higher debt service for anyone with variable rate liabilities (and this includes anyone with credit card debt, an adjustable rate mortgage, etc.), accelerating food prices, etc. are a stranglehold on a consumer experiencing negative real wage growth. The macro economic outcome will simply depend on how tight these forces choose to grip. In our minds, this is the real issue of the moment, not some arbitrary monthly adjusted and massaged payroll headcount number.
Very quickly, it's not just broad domestic service sector wages that are being constrained right here. One of the most important components of the service sector mirrors the macro experience. And this component is the top end of the service sector wage scale.
In addition to service sector wage and salary data, the history of change in unit labor costs also tells a very important macro story of the moment. As you'll see in the chart below, we've now experienced eight straight quarters of negative year over year change in unit labor costs through the first quarter of 2004. This is without precedent in the recorded history of this data. Does this trend suggest inflationary pressures are exploding to the upside? Far from it. As we've suggested far too many times now, the great global macro reflation campaign of the moment is going to be a failed exercise without inflation in domestic wages. And quite simply, domestic wage inflation appears muted at best when looking at both unit labor cost and wage and salary data in the here and now. It is absolutely as plain as day that from the mid-1960's through to the late 1980's, the general level of accelerating inflation during the period was visibly accompanied by inflation in both unit labor costs and wages. In essence, the experience then was about 180 degrees from what is our present set of circumstances.
We've heard it argued that wage and unit labor cost experience are lagging indicators. Now that payroll employment headcount is starting to expand in relatively meaningful fashion, wage pressures are sure to build, right? One piece of data in the April employment report was a bit out of sync with the apparent monthly strength in hiring. And that data point was the average work week. The work week registered 33.7 hours in April. This is up from a deep cycle low of 33.6 hours over the prior six months. Let's face it, a meaningless difference in the greater picture. Shouldn't the workweek begin to increase a bit before actual wage pressures begin to assert themselves? You'd sure think so. In the last cycle of the early 1990's, the average workweek began to accelerate noticeably in 1991. It wasn't until 1992-1993 that the rate of change in unit labor costs and wages began to turn up in cyclical fashion.
If history is to even come close to repeating itself, we should see the average workweek move higher prior to anticipating wage and unit labor cost pressure. But this circles back to the primary issue at hand in our minds. While households that are more financially levered than at any time in modern financial history are "waiting" for real wages to accelerate to the upside (lag or no lag), their consumption dollar is going to be squeezed by currently higher interest rates, energy prices, and a rise in the nominal dollar cost of non-discretionary household goods. In short, the longer the lag or wait, the larger the squeeze.
Is It Different This Time?...To suggest we're in a very rapidly changing global economic environment of the moment risks dramatic understatement. As we contemplate the domestic labor market and associated unit labor cost and wage movement, we need to ask ourselves whether "it's different this time" in terms of the historic relationship between labor costs and headline rates of inflation. For now, are bond market machinations really built on exploding inflation fears, or simply on the exploding fear of potentially exploding underlying investment leverage? We believe it's a key question in terms of assessing investment opportunities ahead. If real inflation is about to rocket higher, bonds could be entering a secular bear market. Alternatively, if the unwinding of unprecedented leverage is really driving action in bond land at the moment, at some point when this process is near completion, fixed income will be a buy. |
