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Brian Andrew, CFA

Jobs, Jobs, Jobs

Economic and job growth go hand in hand. When the economy improves, more jobs are available. As the labor market tightens, reflected in a declining unemployment rate, we should see an acceleration in wage growth. However, one of many conundrums the current economic environment has posed is why, with unemployment so low, hasn’t wage growth accelerated more this late in the growth cycle? The answers may be in the cross-currents of population growth, labor force participation and companies’ growth prospects.

Constructing the Employment Picture

The current unemployment rate is 4.2%. This Friday we will get another look at how the employment picture is faring with the October report. We pay attention to the employment picture for several reasons. The unemployment rate provides a clue as to how much slack there is in the labor market. The lower the rate, the less slack. The data also gives us information about what age groups are participating in the labor market, which industries are growing wages and whether or not people are finding the kind of work they want, e.g., full or part-time.

We know that the Federal Reserve pays a lot of attention to the labor markets and the growth rate of wages; they have stated that maintaining full employment, in addition to price stability (rate of inflation), is part of their mandate. This means the numbers on Friday play into the Fed’s future expectations for the direction of interest rates.

The chart below provides a picture of how unemployment and wage growth have changed over the last 10 years. The gray bar represents the last recession. You can see that the unemployment rate ran up to 10% while wage growth began to fall from near 4% as more and more people became unemployed. Then, as the unemployment rate fell, you can see that wage growth really stayed relatively flat until early 2016. At this point, the unemployment rate had been cut in half and was near what the Federal Reserve called full employment. Since then, the unemployment rate has continued to decline and, finally, wage growth has begun to pick up, although it still remains below 3%.

Change in Unemployment and Wage Growth

What’s Different Now

The 2008-2009 recession was deep and pushed many people out of the labor force as a result of the collapse in corporate revenue and earnings. As the demand for labor began to return, companies were very cautious about hiring full-time people and turned to part-time and contract employees to fill their growing needs. However, because the economic growth rate has been so slow, averaging just over 2% for the last several years, companies’ revenue growth has been almost non-existent (until last year), resulting in slower conversion of those employees to full-time.

In addition, the aging baby boomer workforce began to retire out of the job market. That, coupled with very modest population growth, led to a smaller growth rate in the overall workforce. The chart below shows the steady decline in the population growth rate from 2000 and the growth in the labor force. You can see that in 2015, these two lines crossed, and finally the growth rate in the labor force exceeded the population growth rate. That is a function of a higher labor force participation rate (those discouraged and part-time seeking full-time workers coming back to the workforce).

With the faster growth rate, the slack in the labor market began to decline in 2016 and forced the unemployment rate below 5%. It is likely that this trend will continue, and in 2018 we may see a national unemployment rate that is actually below 4% — something we haven’t seen in decades.

Growth in U.S. Population and Labor Growth

This improvement in participation comes at a time when companies have also seen an increase in revenue growth. That revenue growth leads to better corporate earnings. Since the beginning of the year, corporate earnings growth for companies in the S&P 500 Index has exceeded 12%, almost twice the long-term average. With real demand lifting revenue and earnings growth, companies will be willing to raise wages and, as noted in the first chart, you see the average hourly earnings growth rate begin to accelerate later in 2015.

In 2017 we are also beginning to see an increase in the labor force participation rate among millennials (those born between 1980 and 2000). This will grow the labor force with people whose skills are more likely to reflect those needed.

However, the skills gap in the U.S. remains a critical issue as reflected in the JOLTS report (Bureau of Labor Statistics Job Openings and Labor Turnover Survey). The number of open unfilled positions has gone from 2.2 million in 2009 to more than six million today!

Wage Inflation/h7>

While there is good news in the labor market, we must continue to monitor the growth rate of wages carefully. The overall rate of inflation has remained subdued for the last several years. Although we expect that inflation will rise, partly due to the increase in the wage growth rate, we don’t think it will reach a level, this late in the economic growth cycle, that warrants a dramatic departure from the current monetary policy affecting interest rates. This could mean that intermediate interest rates don’t change dramatically in the next year.

Friday’s update on the unemployment rate will give us some clues as to whether or not the trends we’ve noted here continue or the path is disrupted by a change in the trend. Either way, we’ll be studying the numbers to get a clearer picture on inflation and the impact it may have on our market views.

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Views and comments expressed in this blog are those of the author and do not necessarily represent the positions of Cleary Gull or fellow Cleary Gull associates.