As the world’s largest stock market (the S&P 500) continues to trade near record highs, you’d assume the US economy is strong, right?
Well, it is…sort of.
Second quarter GDP growth came in at an annual rate of 3%, a solid increase on tepid first quarter growth of 1.2%. The unemployment rate currently sits at an impressive 4.2%.
That suggests you should start seeing wage pressures emerging, which should help sustain the economic recovery. After all, consumption accounts for around 70% of US economic growth and rising wages will underpin consumption growth.
But, as in Australia, wages aren’t really growing. At least not as much as you’d expect with the unemployment rate so low.
Wages growth in the US seems to have peaked around 2.5% per annum. Maybe it will accelerate in the future, but at this stage of the expansion you’d like to see wages growth running at a faster pace.
Why are wages struggling to grow? The International Monetary Fund has a theory, as reported by Business Insider:
‘Many economists say they can’t figure out why US wage growth remains so meagre nine years into the economic expansion, especially given a decline in the unemployment rate to a historically low 4.4%.
‘A new study from the International Monetary Fund might help them out. It finds that shifts in the labour market toward less stable, temporary or contract jobs, including odd hours and often no health insurance, likely play a substantial role in preventing wages from rising.
‘That’s because job uncertainty makes it harder for workers to bargain for higher wages, giving employers a strong upper hand in any salary negotiation. The trend is happening not just in the United States but also in other rich economies, the Fund says.’
That may be the case, but it’s a part of a longer term trend. Workers’ share of national income is in long term decline. In 1974 US workers received 64.5% of the national purse. They now receive just below 57%.
Economists and central bankers hope that wages pressures will build in 2018 and growth will break out of its long term stagnation.
But recently released research from Hoisington Investment Management suggest this might not be the case.
Now before I go into the details, keep in mind these guys specialise in ‘fixed income portfolios’. That means they manage bond funds. And bonds tend to do better when the economic environment is less than rosy.
So there is no doubt an inherent bias to look for data that suits the view of a fixed interest manager.
Still, even with that bias in mind, I found the analysis interesting and worthy of sharing with you.
They start off by pointing out that the outlook for US consumer spending is worrying. Over the past year, disposable income growth in nominal terms increased just 2.7%. At the same time, consumer spending grew by 3.9%.
The difference was a result of increased borrowing and a lower savings rate. Consumers are borrowing more and saving less to maintain their standard of living.
They point out that the savings rate had recently dropped to 3.6% of income, which is much lower than the average savings rate (8.5%) that has existed since 1900.
That sounds concerning, but there are a number of reasons to think this is not such a big deal. These days, people consider a build-up of equity in their homes as savings, so comparisons with the pre-financial liberalisation era may not be as accurate.
And even if they are, so what?
How many times during the 2000s did you hear that the US consumer was ‘tapped out’? Then, lower interest rates saw households extract equity from their homes to provide another source of spending.
While borrowing and lowering savings to fund consumption may not be ‘ideal’, it isn’t a reason to be bearish in the short term. Such a trend can continue for years.
What is of greater concern about Hoisington’s analysis is their take on the US Federal Reserve’s tightening path. The Fed is not only increasing nominal interest rates, it is conducting ‘quantitative tightening’ (QT) at the same time. That is, it is shrinking its balance sheet.
The fed has announced QT of US$30 billion in the fourth quarter. Given the money multiplier effect, Hoisington estimates this will reduce the money supply (as measured by M2) by $105 billion. That would see the M2 growth rate fall from 7% in 2016 to around 4.2% by the end of this year.
And if the Fed continued on this path for the first nine months of 2018, M2 would fall to negative 2.8%!
In other words, it is highly unlikely the Fed will continue on its current path of QT. Not without the helpful hand of inflation, anyway. And that remains elusive.
Last week, the release of US inflation data showed core inflation running at just 1.7%, and below 2% for the sixth straight month. That’s more than likely the reason behind gold’s recent recovery to around US$1,300 an ounce. Gold likes lower interest rates.
In other words, the market is adjusting to ‘lower for longer’ interest rates. As long as economic growth doesn’t slow too much, this is the primary reason why stocks will remain elevated.
More on that, and how it relates to the Aussie market, tomorrow.
Editor, Crisis & Opportunity