Wage Growth Momentum - Strong Wage Growth

In previous articles, I have discussed how strong wage growth catalyzed the increase in the 10-year yield in the past few weeks.

Technically, average hourly wage growth missed estimates on a year over year basis as it fell from 2.9% to 2.8%. But this was another strong month for wage growth once you look at the details of the report.

Month over month wage growth met estimates for 0.3% growth. The workweek length was steady at 34.5 hours.

The most important calculation for wage growth is weekly earnings. Year over year weekly earnings growth was up from 3.21% to 3.35%.

This was one of the best reports this expansion. Growth was only higher in June 2018 and October 2010. Wage growth in October 2010 is less meaningful. The unemployment rate was high; fewer workers received those gains.

We often see real wage growth weak at the end of the cycle and strong at the beginning of the cycle. Inflation overheats and then cools off. This isn’t ideal because there are fewer workers during the beginning of the recovery than the end of the expansion.

If tough comparisons prevent inflation from roaring in the next 6 months, real wage growth will explode. Nominal wage growth momentum is strong.

As you can see from the chart below, the 6-month change in wage growth annualized increased to 3.31%. This is the highest rate this cycle. That’s no surprise because when wage growth hit the peak in 2010, it was very volatile.

The current trend is strong and steady.

Wage Growth Momentum - Labor Force Participation Rate

The last major point to discuss about the September labor report is that the labor force participation rate was steady at 62.7%. The prime age labor force participation rate fell 0.2% to 81.8%.

This is the exact rate it was at in January. The rate bottomed in September 2015 and has gone up slowly since then. This slow increase explains why the labor market still isn’t at full employment.

There’s still slack which can bring this rate up 1-2 more points. The point here is that the labor market can create more jobs in the next 1-2 years, not that wage growth won’t improve.

Workers are becoming more productive and many industries have labor shortages. I expect the weekly earnings growth rate to hit a cycle high by the end of the year.

Wage Growth Momentum - Stocks Fall & Utilities Roar

The stock market had another weak session on Friday, meaning it was a poor week overall. S&P 500 fell 0.55% which means it is down 0.99% from its record close on September 20th.

Nasdaq fell 1.16% and the Russell 2000 fell 0.9%. Russell 2000 has been collapsing recently as it is down 6.24% from its record high on August 31st.

Small caps were the big winners during the few months when traders thought the American economy was going to become extremely protectionist.

Now that the trade deals with Canada and Mexico done, that trade is over.

That underperformance combined with the recent sell-off have pushed small caps close to correction territory. It’s important to avoid being fooled into thinking small caps are a leading indicator.

They are more volatile than the large caps which means long winning streaks and losing streaks occur often.

Every single sector fell except utilities which were up 1.57%. It’s weird to see utilities rising in what is called a rate driven selloff. Utilities should fall because they act like bonds since they have high yields and low earnings growth.

As you can see from the chart below, the ratio between banks and utilities hasn’t followed the 10-year bond yield higher. That’s because the banks haven’t done well and utilities haven’t done poorly.

Since September 26th, the utilities sector is up 4.42%. There was a period in mid-September where utilities fell, but since then there has been a strong reversal.

Many people would buy utilities and sell banks, but I would buy the 10-year bond because I think the spike in yields is off base. It’s fair for utilities to rally if you think the housing market is going to weaken the economy.

The worst sectors were technology and consumer services which fell 1.27% and 1.04%.

Facebook stock fell 0.96% on Friday, meaning it’s down 27.66% from its record high.

Wage Growth Momentum - Treasury Rates Increase Further

The 10-year yield increased another 5 basis points to 3.23% on Friday. This week had a huge sell-off as the yield started the week at 3.06%. As you can see from the chart below, professional forecasters have been wrongly forecasting higher rates for years.

The average 12-month forecasting error is 60 basis points too high. This time the forecast was accurate as the latest 12-month forecast was for the 10-year yield to reach 3.3%.

The two-year yield increased 2 basis points to 2.88%. The curve has been relentlessly steepening in the past 6 weeks. The difference between the 10-year yield and 2-year yield went from 18 basis points at the end of August to 35 basis points now.

I do still think the 10-year yield will get back below 3% at some point in the near future.

Wage Growth Momentum - Conclusion

It doesn't seem that the 10-year treasury can sell off much further in the next few weeks. September wage growth certainly isn’t going to stop it. Weekly earnings growth was only the 3rd best in this expansion.

Even if the economy slows down, it won’t come anywhere near a recession if wage growth keeps accelerating.

I am still looking for the setup where real wage growth spikes in the next 6 months after being about flat in the summer.

Some say the low unemployment rate means the expansion is near its end. However, I think there’s plenty of slack in the labor market to keep the cycle going for over 2 more years.