If you follow the trail, it would seem that the share market rout this past week stems from one piece of data.
In the US last Friday, the Department of Labor released its monthly report showing that wages are on the rise. Compared to a year earlier, wages grew at 2.9% in January.
Wage growth means little if you don’t have a job. Around a decade ago, when unemployment in the US topped out at around 10%, wage growth was the last thing on people’s minds.
Since then, however, unemployment has been steadily tracking down. The current rate of 4.1% is the lowest it has been since 2001.
However, despite the low rate, and the US and global economy chugging along, wage growth has almost been non-existent.
The market took last week’s data as evidence that things might finally be turning around.
Over the last few years, wage growth has been the missing piece in the puzzle. Not just in the US and Australia, but across developed countries as well. Wages have stubbornly refused to rise.
An increase in their paycheques means that consumers can spend more, putting more money into the economy.
However, it also has other ramifications.
There is a labour cost that goes into anything you buy. It applies to both goods and services. If wages start to ratchet up, it makes everything more expensive, thereby helping to stoke inflation.
The trouble for central banks is trying to get the balance right — if they can at all. If inflation rises too far (and fast), central banks need to raise rates to curb people’s spending. In other words, to stop them from consuming too much.
While it all sounds rather circular, it has ramifications for the stock market.
If interest rates start to climb, those that manage money have to decide where to invest their money. With interest rates at record lows — and in some cases negative — plenty poured into global stock markets.
However, should rates rise, this same money could flow back into bonds. Meaning that money could flow out of the markets.
This is why the share market fell last Friday and again on Monday. Investors fear that a chunk of money could be about to flow out of shares. After a nine-year bull market, they worry that it might all be finally running out of puff.
While much has been made of this 2.9% rise figure, though, it is only one part of the picture.
On Tuesday (6 February), the Wall Street Journal showed the following graph of the change in average weekly earnings:
Change in average weekly earnings
Source: Wall Street Journal; US Department of Labor
[Click to enlarge]
What the chart shows is that hourly wages have increased steadily, though only gradually (the grey line), since 2010. With a low of around 1.7% in 2012, January wage growth of 2.9% is the highest since 2009.
However, if you look at the red line, it plots the change in the number of hours worked. While the hourly rate ticked up, the growth in the number of actual hours worked trickled lower.
According to the Wall Street Journal:
‘…the annual change in weekly wages for all workers rose 2.6% on the year, below gains of 3% in December and 3.1% in November.’
In other words, taking both into consideration, wage conditions have dropped over the last three months. It is not as clear-cut as the headline number suggests.
The article also noted that ‘all of the gain in Friday’s report came from the smaller subset supervisors and nonproduction workers, who saw wages rise 5% on the year.’
Meaning that only a small group enjoyed a pick-up in wages. The rest are still stuck with little meaningful wage growth. Meaning that this supposed extra money from bigger paycheques might not find its way into the economy.
The other thing is that the market had already peaked on 26 January — before the release of the jobs report. What the report did was spook a market that was looking for a reason to sell.
It also reminded complacent investors that markets don’t always go in a straight line. That an increase in volatility is here to stay.
When the markets run away to big gains, quite often it is the growth stocks that propel it higher. But these can be the first stocks the market abandons when it turns the other way.
Growth stocks can help increase the value of your portfolio. However, this recent fall also reminds us that we need something else…income stocks.
Income stocks — companies that generate cash and share that with their investors — might not always enjoy big gains in a bull market. But for all the other times, their resilience can form the backbone of your portfolio. And pay you a handy income.
All the best,
Editor, Total Income