Labour Intensity, Wage Pressure, and Why People Are Quitting Their Jobs

The Echelon Insights Team • Oct 18, 2021

Inflation sucks. It is essentially a tax on those consuming goods or services, as things simply cost more. Even worse, it is a regressive tax given lower income/wealth consumers tend to spend a higher portion of their income. Now, if you are sitting comfortably on your nest egg and not spending too much, should inflation worry you? That depends on this raging debate as to whether the current spike in inflation is a blip caused by temporary demand and supply imbalances…or the start of something longer term. If inflation runs hotter for longer, the value of that nest egg erodes in real terms—clearly a risk to any long-term financial plan.

Currently the good news is higher prices have been predominantly found in what the Atlanta Fed calls ‘flexible priced categories.’ Breaking down the categories in the Consumer Price Index (CPI) into those that are flexible and those that are sticky clearly demonstrates that the headline number is being almost completely pushed higher by the flexible categories. The good news is the prices in these categories can come back down just as fast, supporting the “inflation is transitory” argument. In fact, many have started this descent.

A confluence of factors caused the CPI spike. The pandemic disrupted logistic supply chains that have been increasingly run tighter over the years to reduce costs. Demand came back faster than expected and focused more on durable goods. Global spending behaviours changed quickly. Meanwhile supply adjustments are not as quick. Based on manufacturing survey data, it appears that the worse may be behind us. Readings are still high in many PMI survey questions, including slower delivery times, customer inventories too low, and backlogs rising, but they appear to have peaked a few months ago and are moving in the right direction.

So, all clear on inflation then? Not so fast. The headline inflation should continue to come back down as supply gradually adjusts to demand, but there are now signs of wage pressures building. Wages are more dangerous as they rarely ever come back down. Not sure if you have ever tried to tell an employee they will make less next year, not a frequent conversation for anyone. Of course, some may recall the wage spiralling in the 1970s that contributed to very high levels of inflation. For while wages are not a category in CPI, they feed into the cost structure of so many categories, it can be a material contributor to more widespread inflation.

The signs of wage pressures are not at all alarming today, but they have been building. Atlanta Fed’s wage tracker is currently showing 3.9% growth in wages, which is high but not too concerning. But there are other signs, such as rising overtime and an increasing quit rate, that can’t be ignored. People have been quitting at a record pace—the quit rate was 3.6% in August, which is the highest pace people have voluntarily left their jobs since the data series began in 2001. Before this summer, the quit rate had never even been over 3%. Why is this worth highlighting? Well, people rarely quit their jobs to take one with a lower or the same wage: it is more often for more money.

Indications of wage pressures are also starting to increasingly show up on company earnings calls. Scanning for the frequency of executives using the phrases “wage pressure” or “labour shortage” during earnings calls shows there is mounting concern. A few industries mentioning these risks the most often over the past three months have been hotels, restaurants, commercial services (i.e., logistics companies), and banks.

We have already seen some companies either warn or miss earnings with management attributing wages and labour as negative contributing factors, which brings up the topic of labour sensitivity. Some companies use more capital relative to labour to generate sales. Energy, utilities, and communication services, for example, are capital intensive. This makes them less sensitive to wage pressures. Meanwhile, consumer discretionary, industrials, and consumer staples tend to use more people to generate sales, meaning the sectors are clearly more at risk. Of course, it really depends on the specific company as these sectors are rather broad and capture many sub-industries. For example, health care looks relatively safe given the sales per employee. Although while this may be the case for pharmaceutical companies, it is less so for health care service providers.

Investment implications

The transitory argument could be applied to labour as well as it pertains to wages. The pandemic caused some jobs to disappear for over a year, other jobs were in super high demand, and government jumped in to send enhanced benefits to many. Now service jobs are coming back, demand is normalizing, and benefits are fading. Is it any wonder distortions in the labour market are causing wage pressures given these gyrations?

These may fade in the longer term as the market adjusts, but for now the risk is for rising wage pressures in the months/quarters ahead. If this does occur, central banks are likely going to speed up their removal of supportive measures. While they can ignore transitory inflation pressures, wages are another matter. Investors in individual equities may want to dig a little deeper to ascertain their portfolios sensitivity to higher wages or reduce in case these pressures continue to build.

Charts are sourced to Bloomberg L.P. unless otherwise noted. This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

The contents of this publication were researched, written and produced by Richardson Wealth Limited and are used herein under a non-exclusive license by Echelon Wealth Partners Inc. (“Echelon”) for information purposes only. The statements and statistics contained herein are based on material believed to be reliable but there is no guarantee they are accurate or complete. Particular investments or trading strategies should be evaluated relative to each individual's objectives in consultation with their Echelon representative.

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This is not an official publication or research report of Echelon, the author is not an Echelon research analyst and this is not to be used as a solicitation in a jurisdiction where this Echelon representative is not registered. The information contained has not been approved by and are not those of Echelon, its subsidiaries, affiliates, or divisions including but not limited to Chevron Wealth Preservation Inc. The particulars contained herein were obtained from sources which we believe are reliable, but are not guaranteed by us and may be incomplete.

Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. Echelon and Richardson do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements.

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Rarefied Air

By The Echelon Insights Team • 12 Oct, 2021

The market advance over the past year has truly turned a lot of heads, in a good way. After the initial bear and bounce triggered by the Covid-19 pandemic, markets went on a phenomenal run. The rollout of vaccines driving the re-opening trend in the economy helped, as did the continued emergency monetary and fiscal support policies. And what a run. During this advance, consumer spending pivoted much more to durables such as vehicles, homes, and technology. While nominal GDP doesn’t care as much where an individual decides to spend their money, the equity markets much prefer you buy some durables instead of services (like a dinner).

Why we’re preparing for a turbulent year end

By The Echelon Insights Team • 04 Oct, 2021

Challenges ahead — Greg Taylor September has once again lived up to its reputation for volatility. In many ways this had to be expected as equity markets have experienced one of the longest runs of stable returns and minimal drawdowns in history. However, the timing of this recent volatility should not surprise many, as most of the positive tailwinds that have carried the market to these levels are starting to fade away, setting up what could be a difficult period for capital markets. Global central banks are the biggest and most important factor that have helped elevate recent returns. To their credit, they learned from the mistakes of the global financial crisis where indecision and delay exacerbated things—this time, right from the beginning, the banks did everything they could to help the markets and the economy. But all good things must come to an end, and 18 months after the start of the pandemic, it is time for central banks to begin to remove some emergency measures. This isn’t a bad thing at all. Central banks need to begin to normalize policy to prepare for the next crisis. But it is a change from the recent normal and means that central banks may be less accommodating for the next while. This action resulted in bond yields moving higher across the curve and has led to a change in sector leadership. The growth/value trade has been a subject of much debate over the last few years. As growth has dominated in a period of ever lower bond yields, with the threat of inflation, has this turned? Will the rally in energy be the trigger to get this going once again? The energy sector was a victim of the climate movement, but the resulting cuts to production may be setting us up for a bull market in the commodities as we are already seeing shortages in both natural gas and heating oil. The resulting price increases is also adding further ammunition to the inflation argument as higher costs will undoubtably flow through to the price of goods. What no one really expected in the month was the China risk. Consistently over the last year, China has been working to extend their influence over the capital markets, which has caused many to question if China is at all investible? Their constant clamp down on social media and other growth sectors became a secondary concern as their largest construction company ran into liquidity issues. Evergrande was never going to be a Lehman moment, but it had the potential to leave some scars. For the moment, this risk has faded to the background, but it can’t be ignored and has the potential to flare up once again. What could prove to be the biggest risk to the markets in the near term is earnings season. With the advent of quant funds gaining a greater market share, we have seen companies that beat earning expectations gain versus those that don’t. But as easy comparable estimates fade, huge beats will be harder to achieve. We have already seen some notable companies miss these expectations and the risk is that the next month will be filled with negative earnings revisions. One of the biggest reasons for earning misses has been from broken supply chains. Covid lockdowns and pulled-forward demand for goods did immeasurable damage to the concept of ‘just-in-time’ inventory models. Companies continue to scramble for components, such as semiconductors, in order to product goods. As indicated by the surge in used car prices, the automotive sector has been one of the hardest hit. Until this is fixed, we must expect inflated prices of goods and services and squeezing margins. Whether this is temporary or permanent is still up for debate, but its another headwind to markets.

Q3 earning season – no cake walk

By The Echelon Insights Team • 27 Sep, 2021

The life blood of the equity market is the earnings generated by the companies in the index. Sometimes the market pays more for these earnings, like these days, sometimes less. For instance over the past decade, the Price-to-earnings (PE or market multiple) for the S&P 500 has ranged from 10.3 to 23.2 with the current level at 21.1. This is based on forward 12-month consensus estimates for earnings. Canada’s TSX has a similar range, 10.8 to 20.8, although its current PE ratio at 16x is not in the upper range. Attempting to understand how much the market will pay or value $1 of earnings clearly changes and sometimes it changes fast. The market multiple is influenced by many factors. Yields in the bond market have an influence given this is a competing asset class to equities. Historically, higher yields have coincided with a lower PE ratio for the equity market. I mean if you are going to receive say a guaranteed 5% coupon from bonds, you won’t pay as much for a $1 of earnings given all the added uncertainties with equities. These days with low yields, equity PE ratios tend to be higher. However, the biggest driver of the market multiple is the outlook. If the economy is doing well, with few clouds on the horizon, the PE ratio tends to be higher. When uncertainty about the future path of the economy rises, investors won’t pay as much for earnings as the future path becomes less certain.