By Jamie Chisholm
It’s jobs Friday. The release of the U.S. monthly nonfarm payrolls report is always a highlight for Wall Street – particularly so in an uncertain monetary policy environment, when traders are hyper-sensitive to factors impacting Federal Reserve thinking.
Indeed, the resilient labor market is causing many market observers to argue that despite suffering two successive quarters of contraction the U.S. economy is not really in a ‘proper’ recession.
These recession deniers are wrong, argues Dhaval Joshi, chief strategist for BCA Research’s Counterpoint in his latest note published before Friday’s blow-out jobs report. It is a recession, albeit a ‘topsy-turvy’ one! Why? Because real labor costs are falling.
Firms lay off staff when they need to protect profits, he explains. In the past, when nominal sales have fallen relative to wage rates, then unemployment always has risen.
But during a recession in which nominal sales do not shrink relative to wage rates, profits remain resilient, and so companies do not need to cut back labor costs. This is occurring now.
“In the topsy-turvy recession of 2022, there has been much greater inflation in consumer prices and nominal sales than in nominal wage rates. The result is that real wage rates have collapsed, profits have stayed resilient, and firms have not needed to lay off workers… so far,” says Joshi.
Consequently this recession is fairer, reckons Joshi.
“In a typical recession, the pain falls on the minority of workers who lose their jobs, as well as on profits. Paradoxically, for the majority that keep their jobs, real wages go up. This is because sticky wage inflation tends to hold up more than collapsing price inflation.”
Yet in the current downturn the real wage rate has declined by 4% “meaning that the pain of the recession has fallen on all of us…This is confirmed by the current malaise being characterized not as a ‘jobs crisis’, but as a ‘cost of living crisis”.
So, what happens next? Keep an eye on consumer price inflation and company sales. Once firms’ revenue growth starts dropping below the stickier wage growth, profits will decline and managers will look to trim the workforce.
“If inflation comes down slowly, then the current ‘cost of living crisis’, which is pummeling everyone’s real incomes, will persist. But if inflation comes down quickly while wage inflation remains sticky, firms will be forced to lay off workers to protect their profits, turning the ‘cost of living crisis’ into a ‘jobs crisis’, ” Joshi says.
And what are the conclusions for investors ? Well, in either scenario consumer spending, particularly on goods, will be crimped. Housing investment will remain in contraction until mortgage rates move notably lower.
“This double choke on growth is likely to keep a lid on ultra-long bond yields, even if central banks need to hike short-term rates more than expected to slay inflation,” says Joshi.
“For the stock market, this suggests that the valuation bear market is now over, but that ‘cyclical value’ sectors are now vulnerable to profit downgrades. Hence, equity investors should stick with ‘defensive growth’, specifically healthcare and biotech,” he concludes.
Equity markets are under the cosh following much stronger than expected jobs data. At 528,000 positions added, the number for July was more than double consensus estimates. The pace of wage growth increased from 0.3% to 0.5%, again faster than forecast.
Good economic news is being taken as bad news because it may encourage the Fed to tighten policy more aggressively. S&P 500 futures /zigman2/quotes/209948968/delayed ES00 -0.02% are down 0.7% to 4,122 and Nasdaq 100 futures /zigman2/quotes/210219788/delayed NQ00 -0.32% are dipping 0.8% to 13,222.