This note was originally published at 8am on December 10, 2014 for Hedgeye subscribers.
“U-G-L-Y, You Ain’t Got No Alibi”
Every year around the holidays I make a point to pick up a stranger, fund a trip to the nearest fast food drive-thru and further them towards wherever “point B” happens to be.
I picked up my first hitchhiker in four years this past weekend.
My multi-year drought in holiday humanism hasn’t been intentional, there’s just been a secular bear market in central CT hitchhiking.
My father started the tradition when I was young. He passed away when I was 17 and I’ve carried on the tradition over the last decade+.
It’s an homage of sorts and my way of paying-it-forward.
Back to the Global Macro Grind….
The thing about ‘paying-it-forward’, in real terms, is that one generally has to get paid to begin with.
While the recent crescendo in Energy/Russia/Greece crashing captions has dominated newsflow the last couple weeks, accelerating wage inflation – and its seemingly perpetual imminence – remains a trending and favorite topic for headline writers.
Indeed, slack reduction and the hoped-for flow through to wage inflation has been the bull case for purveyors of panglossianism for the last year.
The flow of Wall Street wealth to Main Street income remains core to Janet Yellen’s policy calculus as well – and front-running reactionary central bank policy remains the game – so the iterative, Bayesian review of the monthly labor/wage data remains a ceaseless exercise.
THE THEORY: Conventionally, wages are viewed as a lagging indicator, with wage inflationary pressure building as the labor supply declines and the economy moves towards constrained capacity.
That an output gap still exists in the domestic economy remains readily apparent. The core of the slack debate continues to center on the magnitude of the shift in labor supply-demand dynamics and whether policy makers will move ahead of or behind any emergent inflationary curve.
THE (RECENT) SLACK DATA:
- Quits & Hires: Yesterday’s JOLTS data showed voluntary separations (Quits) held above 2.7MM for a second consecutive month – the highest level since February 2008 – while total hires held above 5MM for a second month for the first time since December 2007.
- Available Workers per Job Opening: Available Workers (the sum of Unemployed + those Not in the Labor force but Want a Job) per Job Opening (JOLTS reports) dropped to 3.21 in October – marking a new cycle low and dipping below the pre-recession average of 3.31.
- Short-term Unemployed, % of Total: The share of short-term unemployed - those unemployed for less than 5 wks – made another new cycle high, increasing to 27.6% of total in November. While the share of total has typically ranged between 40-50% at peak in prior cycles, the trend in the current cycle remains one of ongoing improvement.
- NFIB Hiring & Compensation: The Small business optimism data for November, released yesterday, showed hiring plans, compensation, and difficulty in filling positions all remain positive with each increasing sequentially and sitting jut below recent cycle highs.
So, the continued, albeit frustratingly slow, transition to tautness remains ongoing on the labor slack front. Does that portend material (imminent) upside in wage growth?
- Nominal Wage growth over the last 3 cycles (1982-2007) has peaked at just north of 4% and has averaged 3.3%. Real Wage growth, however, has been largely a phantasm – particularly for the median and lower income quintiles.
- The lone long-term data set on realwage growth – which focuses on production and nonsupervisory workers - shows real wage growth has been flat/negative for most of the last 4 decades. The current post-recessionary progression in real wage growth actually compares favorably with those observed over the last half century.
- Labor’s share of National Income only rises at the tail end of an expansion and after growth and profits have been strong for a protracted period.
Remember too that those averages were achieved alongside peak positive demographics, accelerating credit growth, and a favorable interest rate backdrop.
Is a return to a halcyonic 3-4.5% level of nominal wage growth in the face of persistently lower inflation, an aging workforce, top heavy demographics, lower productivity and lower credit growth a reasonable expectation?
We don’t think so.
Hourly wage growth for the private sector has been stuck at ~2% for the better part of the last four years. The trend in wage growth for production and non-supervisory workers (+2.4% in November) has been better but not great.
Assuming there is an intermediate-term to the current expansion (now 67 months old), there is probably some runway for further wage gains but with upside to something closer to ~+2.5% than to the ~4% (a double from current levels) of prior cycle peaks.
Strong dollar deflation and a protracted deceleration in global growth should only constrain the upside for domestic inflation.
To review the current state of the top 7 Global Economies:
- United States: Good - but slowing from a rate of change perspective
- China: Ugly - Growth slowing, Disinflation rising (printed 5Y low last night), central bank easing
- India: Good - growth improving & inflation worries ebbing with Dr. Raj doing a credible job at the helm of the RBI
- Japan: Ugly - Yen crashing, economy slowing, Abe/Aso scrambling
- Germany/Eurozone: Ugly – deceleration growth and disinflation prevailing, Incremental CB easing imminent
- Russia: Disaster – Ruble is crashing, GDP is looking like -6-8% at current oil prices, risk of a banking crisis is rising
- Brazil: Ugly - perhaps some interesting upside in another quarter or so but, for now, Brazilian policymakers/economy (still) can’t get out of their own way
If you’re keeping score that’s: 4 Uglies, 1 Disaster, and 1.5 Good
What say prices/markets about those macro realities?
- Global Growth and Inflation Revisions = negative
- 10Y Yield = -27% YTD, Bearish Formation, immediate-term downside to 2.16%
- Yield Spread (10’s -2’s) = 52 Week Low
- Inflation Expectations = Crashing
- Energy Equities & Commodities = Crashing
- Style Factor Performance = Low Beta, High Yield, Large Cap Outperforming (across durations)
- High Yield = Breaking Out and holding at 52-wk highs.
In his keynote address to the CATO institute, Jim Grant presaged that a summary analysis of the 2016 crash will sound something similar to the following:
“My generation gave former tenured economics professors discretionary authority to fabricate money…we put the cart of asset prices before the horse of enterprise…we entertained the fantasy that high asset prices made for prosperity, rather than the other way around.”
With hedge fund trailing correlations to beta >0.90 and rampant central bank interventionism starving the alpha from active management, most investors, wittingly or not, have just been along for the five-year ride.
Thumbing for central bank (helicopter) rides….no secular bear market there.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.16-2.26%
Oil (WTI) 60.94-66.99
To chickens & eggs, carts & horses, paying it forward & having it to begin with.
Christian B. Drake
U.S. Macro Analyst