Today I’d like to answer a question that is on many economists’ and traders’ minds. It concerns wage growth, or more accurately, the lack thereof.
According to the December employment report released this past Friday:
“In December, average hourly earnings for all employees on private nonfarm payrolls decreased by 5 cents to $24.57, following an increase of 6 cents in November. Over the year, average hourly earnings have risen by 1.7 percent. In December, average hourly earnings of private-sector production and nonsupervisory employees decreased by 6 cents to $20.68.”
While wages in America are rising, they are not rising fast enough for many economists’ liking, and they are letting us know it:
“Average hourly earnings were the biggest disappointment in the report,” noted the U.S. Economics Team at BNP Paribas.
“Hourly earnings were a real disappointment,” reiterated Rob Carnell at ING Bank. “Just when it looks as if the U.S. is about to see a step up in the wages figures, not only do you get a weak figure (-0.2% month-over-month) but large revisions to past data, and the wages growth rate has plunged back to 1.7% year-over-year from 1.9%.”
Even the president of the Chicago branch of the U.S. Central Bank, Charles Evans, expressed his frustration with the painfully slow wage growth: “We ought to see wages in the 3-4% range, not where they are right now,” he stressed.
Just why is everyone so concerned about wage growth? Because it is keeping the nation from returning back to normal. How? By keeping the U.S. Federal Reserve from returning interest rates back to normal.
Despite stellar jobs growth, despite great strides in lowering the unemployment rate, despite great growth in GDP now over 3%, stagnant wages are the one thing holding the Fed back from raising interest rates and taking itself out of the picture.
“If you want to raise rates, these numbers provide the ammunition you need in terms of payrolls [wages] and the unemployment rate,” Carnell explained.
The conundrum leaves many scratching their heads. How can the economy be growing so strongly, with such great employment numbers month after month, and yet have wages growing at an appalling 1.7% per year? The answer to that question lies in one very important number on the monthly employment report – a number which has been conveniently removed from the calculation.
Those Other Unemployed
Before getting to the reason why America isn’t seeing wage growth despite such a robust economy currently growing at 3% annual GDP, we need to note how the unemployed have been divided into two groups.
According to the employment report, “the number of unemployed persons declined by 383,000 to 8.7 million” last month. That’s the main group of unemployed. But there is another group of unemployed persons that really messes up the numbers:
“In December, 2.3 million persons were marginally attached to the labor force… These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.”
How does this second group of “marginally attached” unemployed mess up the numbers? Because in reality, the U.S. has 11.0 million unemployed persons, not 8.7 million. This means the unemployment rate is not 5.6% but is actually higher at 7.1%.
According to the simple rule of supply and demand, having so many unemployed persons – including those marginally attached whom the report admits “wanted and were available for work” – affects wages in the same way that the glut of excess oil has been affecting the oil price… it keeps the price down.
Employers do not need to raise wages to attract applicants, for from the moment they advertise a job opening they are swarmed with unemployed persons eager to fill them. It’s an employer’s market out there, and until the “total” number of unemployed persons falls dramatically, there will not be any wage increases to speak of.
Job Growth Not Keeping Pace
Making the situation for wages even worse is that despite such fantastic job creation averaging more than 200,000 per month for some 4 years, and despite having reclaimed all the jobs lost during the last recession plus more, job growth has not kept pace with population growth.
In January of 2008, shortly before the economy crumbled, America’s population stood at roughly 301.23 million people. By January of 2014, the population had grown to 317.3 million, for a total growth rate of 5.33%, or 0.889% per year.
But given the loss of millions of jobs during the 2008-09 crisis, job creation has not kept pace with that population growth. With 146.5 million employed persons in December of 2007, the U.S. economy needed to add 9.117 million jobs from December 2007 until December 2014 (calculated at 0.889% per year for 7 years, or 6.223% in total) in order to keep up with population growth.
As it is, from December 2007 to December 2014 only 942,000 new jobs have been added. (Remember, 8.5 million jobs were lost from 2008-09, while 9.442 million have been added back, for a net gain of just 942,000 over the past 7 years.)
So where we needed 9.117 million net new jobs over the past 7 years, the actual number of 942,000 net new jobs is barely 10.332% of the amount needed. That’s right, barely one tenth of the new jobs required to keep up with the growth in population.
This is made evident by the continually dropping labor force participation rate as graphed below, which has been plunging since the 2008 recession and has still not stopped falling. The labor force participation rate measures the percentage of the population that is either working or actively looking for work.
Source: U.S. Bureau of Labor Statistics
What it Means for Investors
Now we know the reason why wages are not increasing in the U.S. despite such stellar job creation as of late. The loss of 8.5 million jobs from 2008-09 has taken over 6 years to earn back, leaving us far behind in keeping up with population growth, creating an oversupply of laborers in America. And as the laws of supply and demand dictate, whenever you have an oversupply of something, its price will plummet. We’ve seen it in oil, and we’re still seeing it in wages.
At the current rate of 1.7 million fewer unemployed persons per year, it will take another 4.8 years to draw-down that 8.175 million job shortfall that has been accumulating through population growth since 2007.
While wages are growing at a modest 1.7% year, we should not expect to see them grow much faster than that for a while, at least not until we see a substantial reduction in the number of unemployed and marginally attached workers which currently number 11.0 million.
What does all of this mean for investors?
“It was more of the same for U.S. employment in December,” answers Avery Shenfeld of CIBC WM Economics, “with a notable exception in the wage data that could give the Fed some dovish food for thought.”
Low wage growth equals low inflation expectations, which equals low interest rates for a while longer. As long as wages remain low, inflation in consumer prices cannot take hold, since consumers are not earning more to keep buying at higher prices. Low wages keep consumers’ buying power weak, which prevents prices at shops from rising, which prevents inflation from taking hold, which prevents the Fed from raising interest rates. Since higher interest rates put downward pressure on inflation, there simply isn’t enough wage growth to lift inflation enough to counter any move higher in interest rates.
As the president of the Chicago branch of the U.S. Central Bank, Charles Evans opined: “I just don’t see why we should be in a hurry to move off our current accommodative policy.”
The Fed is likely to keep interest rates where they are at near zero for the remainder of 2015. In turn, that means U.S. equities still have much further to run up in value.
Of course, it also means bonds will likely remain strong and their yields low for the rest of 2015 as well. But if we had to pick one or the other, the best bet would be U.S. equities, since bonds have nowhere to go but down, while stocks will continue to have this amazing low-interest rate wind lifting them higher for years to come.