Wage Pressures Mounting

Recession Indicators Update

Wage Pressures Mounting

Wage pressures are mounting, which could lead to higher inflation – yet commodity prices have improved. That leaves the ClearBridge Recession Risk Dashboard overall signal unchanged at a cautionary yellow.


Key Takeaways
  • Wages continue to rise, particularly for lower earners -- which has moved the ClearBridge Recession Risk Dashboard's Wage Growth indicator from yellow to red.  While this may be a short-term positive to consumption, over time it should lead to higher inflation as companies raise prices to defend margins.
  • Wage Growth is one of the longer leading indicators on the Dashboard.  As a result, this change does not signal a material shift in the near-term recessionary outlook.
  • The Commodities indicator, however, improved from red to yellow -- and the overall signal from the ClearBridge Dashboard remains unchanged at a cautionary yellow.
Growing Wage Pressure from Lower-Paying Jobs

The ClearBridge Recession Risk Dashboard experienced two changes during November, with Wage Growth turning to red from yellow and Commodities improving to yellow from red.  Having previously detailed commodities, this month we will focus on wages.  Rising wages are a double-edged sword for the U.S. economy, as we outlined earlier this year. On the positive side, higher wages can help boost consumption which tends to be the primary driver of U.S. economic activity.  Rising compensation can also bolster savings, and consumers are now saving 8.3% of their disposable income, up nearly four times from the 2005 low.  While higher savings has contributed to slower economic growth, it has helped strengthen consumer balance sheets which should allow for greater spending in the event of a sustained slowdown. 

The downside to stronger wage growth is the potential to hurt corporate profitability, as wages are one of the largest expenses for most businesses and those in the services sector particularly.  If companies raise prices in order to maintain margins, this can lead to inflation which, in turn, can lead to a more hawkish U.S. Federal Reserve that raises rates more aggressively.  Additionally, layoffs could become more commonplace as we are late in the economic cycle and companies may be unable to fully raise prices to offset higher compensation costs.  This can drive a negative feedback loop, with slower consumer spending and economic activity.  Tight monetary policy and rising unemployment can be a powerful recessionary concoction.  While higher wages are often a short-term benefit, over time they have the capability to do harm.

Corporate profits typically get squeezed the most when wage increases outpace productivity gains.  This is currently the case, as over the past five years overall wage growth has averaged 2.7%, well ahead of the 1.0% average increase for labor productivity (output per hour).  Several months ago, the Profit Margins indicator on the ClearBridge Recession Risk Dashboard turned yellow as this dynamic started to take its toll on the small businesses that are the country's primary employers.  Larger businesses are also seeing margin pressures, with the contribution to growth from margins for the S&P 500 Index constituents having been negative for the last two quarters.

The latest data does not show that wage pressures are abating, either.  While the headline figure for wage growth has softened a bit and is now running at 3% per year, median wages are growing at a cycle-high 3.5%.  Demographic shifts are partly the reason for the divergence between the average and median figures.  As older, higher earning workers exit the labor force and are replaced by younger ones at lower salaries, the average gets pulled down.  The median figure is less impacted by this dynamic and as a result can be more representative of the wage gains the typical worker is receiving.

Exhibit 1: Lower Paying Jobs Have Seen the Strongest Wage Gains

Source: Federal Reserve Bank of Atlanta, as of 10/01/2019. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

An additional source of wage pressure is coming from stronger raises for lower-earning workers.  Salaries for production and non-supervisory workers are growing at a higher rate (3.5%) than the national average.  Eighty percent of Americans have these types of jobs, which on average pay about half of what the other 20% of Americans earn.  This divergence is also evident when looking at wage gains for the top and bottom quartile of earners (Exhibit 1).  While the early part of the expansion was defined by faster wage gains for the top earners, this flipped around in 2015, and the bottom earners have been leading ever since.  Currently, these lower wage earners are seeing very strong increases of 4.4% annually.  In the short term, this can result in a larger boost to consumption, as lower wage earners typically have a higher propensity to spend.  However, the same longer-term drawbacks described above are likely to play out here as well.

Exhibit 2: ClearBridge Recession Risk Dashboard

Data as of Nov. 30, 2019. Sources: ClearBridge Investments, BLS, Federal Reserve, Census Bureau, ISM, BEA, American Chemistry Council, American Trucking Association, Conference Board, and Bloomberg. The ClearBridge Recession Risk Dashboard was created in January 2016. References to the signals it would have sent in the years prior to January 2016 are based on how the underlying data was reflected in the component indicators at the time.

The Wage Growth indicator turning to red is an incremental negative, although this indicator has traditionally been one of the longer leading indicators ahead of recessions. While its efficacy in this cycle will only be known with the benefit of hindsight, history would suggest this signal change should not be interpreted as an indication that a recession is on the immediate horizon, particularly when combined with the improvement in the Commodities indicator. As a result, our longer-term views on the economic cycle, as well as the overall yellow signal on the ClearBridge Recession Risk Dashboard, remain unchanged.


Definitions:

credit spread is the difference in yield between two different types of fixed income securities with similar maturities, where the spread is due to a difference in creditworthiness.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Institute for Supply Management's (ISM) Purchasing Managers Index (PMI) for the US manufacturing sector measures sentiment based on survey data collected from a representative panel of manufacturing and services firms. PMI levels greater than 50 indicate expansion; below 50, contraction.

The ISM New Orders Index is the new orders component of the ISM PMI.

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.

Top

Important Information

 

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People's Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC's commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC's commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.