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By ContraryInvestor.Com | 2 June 2009
To the point, we want to take a very quick look in this discussion at the complexion and rhythm of US household wages and salaries, and broader personal income circumstances of the moment. The important issue to our forward investment actions and thinking being, in a world where corporations have taken a literal machete to employment costs all in the interests of preserving nominal profits and profit margins, are they essentially destroying the very source from which future aggregate demand will be driven— within the context of a macro household balance sheet deleveraging environment that we believe will also continue for some time to come? [[Not a new question, by any means. It was on the front burner during the Great Depression.: normxxx]]
Moreover, have we entered a bit of a vicious cycle in terms of labor market pressure feeding into wage pressure, feeding into consumption pressure that further constricts corporate profits, ultimately leading to even further pressure on labor costs? We’ll be suggesting to you that current circumstances are very much unlike any prior US economic cycle of the last thirty to forty years at least. We want to try to tie together a number of broader themes we have been discussing for a while now.
Remember that the Employment Cost Index (ECI) that comes to us courtesy of our wonderful friends at the Bureau of Labor Stats (yes, the same folks responsible for the payroll numbers) is made up of two key components— wages and benefits. The current (as of 1Q) year over year change in the ECI is the lowest number in the history of the data. Again, we should not be expecting fireworks, especially in the midst of a deep recession. But in the absence of household credit acceleration, what you see below is the key to future reacceleration of aggregate demand, or otherwise as the case may be.
The history of the two components of the ECI (wages and benefits) is seen below. The year over year change in wages has never been this low in the records of the data. And in terms of growth in benefit costs, we’re pushing historical lows as we speak. What does all of this mean? It tells us labor is under serious total compensation pressure.
And since benefit costs to employers are falling rapidly, this tells us one of two things is correct. Either employees are simply losing employer sponsored benefits (think health insurance) they will need to make up on their own out of wages or total household resources, or their personal participatory costs in employer sponsored benefits are climbing rapidly (think co-pays, etc.). Either way, labor is under serious wage and benefit pressure, really unlike anything seen over the prior three decades at least.
One last chart. This is the history of the year over year change in US wages and salaries from the personal income numbers. We’ve drawn with red bars all of the recessions since 1960 to show you that the year over year change in wages and salaries has actually been quite the tell tale sign of official recession conclusions over this time. Will it be so again? One more time, never over the history of the data (to 1960) have we seen this type of pressure on wages.
We’ll make the following quick, but we want to walk through the remaining components of "household financial wherewithal" outside of wages and salaries to get a broader sense of the current circumstances surrounding the character of personal income. …we believe it's the Fed and Treasury that are in good part acting to hold up the US [[and world?: normxxx]] credit markets and US personal income as well in the current environment.
1. Proprietor’s income. Simply, non-wage categorized income of folks who own businesses. A good read on the smaller business community? Indeed. As of now we’re at a rate of change contraction low not seen since the early 1980’s recessions. Not a positive contributor to personal income flexibility for now.
2. Employer supplements to wages and salaries (think 401k contributions, defined benefit pension plans, etc.). Quite negative; but showing some signs of life as employers must now add to defined benefit plans to make up for stock market losses.
3. Income from assets: virtually 100% driven by household interest, dividend and rental income streams. Quite noticeably this has reached a record low in terms of now being a rate of change drag on household personal income circumstances of the moment— a record rate of change contraction for the entire history of the data.
4. Government social benefits. Modestly positive. Increased social benefits need to occur during recessions, as has been exactly the history of the US for five decades now.
5. Personal only income taxes. As you can see in the chart that follows, the year over year decline is pushing toward the lows seen over the entire history of this data.
By now we’re pretty darn sure you get the picture, so we will not belabor the point. As we stated last month in "Of Fingers And Dikes", we believe the Fed/Treasury/Administration has had a huge hand in supporting and anesthetizing the US credit markets (inclusive of LIBOR). Without governmental/Fed/Treasury support, there is no way the headline credit market data would be showing us as much perceptual [[apparent only?: normxxx]] healing as has been the case up to this point. Of course the key question remains, just when can these folks take their collective fingers out of the multiple holes in the credit market dike. For that, we have no answer.
In like manner, at least as per the data above, it sure appears as if the US government is now a major infrastructural support to the personal income circumstances of just about every individual in the US. Again, this is not wrong and this is not bad. The repetition of this pattern has been seen in EVERY recession of the last five decades at least. It’s just that never have we had the annual rate of change in wages and salaries, proprietor’s income, and income from other assets all in negative rate of change territory on a simultaneous basis over the prior five decades. That highlights and reinforces [[and makes more crucial/critical: normxxx]] the role of the US government in supporting personal income.
So as we step back and contemplate the relationship of labor market conditions, consumer confidence, retail sales trends historically and what the equity market is discounting in price in terms of an economic recovery to come, we need to ask once again, just who (or what?) will fund higher household consumption ahead at the margin absent renewed household balance sheet releveraging? (Moreover, households have shown us they have begun to increase their savings rates. How can we have much higher consumption ahead accompanied by higher savings rates when the key core components of personal income are all in year over year contraction mode?)
We continue to believe the financial markets are trying their best to discount a 'typical' consumer and/or corporate demand led economic recovery of the type seen over the past half century. Yet when we look at things like the credit markets, personal income circumstances and the complexion of household balance sheets crying out for deleveraging, current conditions are quite different than any recession of the prior half-century, with the government acting as Atlas holding up the world of "demand", per se, for now.
Yes, we know that old market saws are hokey, but we can’t get this one out of our minds. First price, then optimism… then earnings. There can be no break in the chain in cyclical bull market character, and the first two have already gone a long way in terms of playing out. Absent household balance sheet reacceleration in leverage it sure seems a good bet forward corporate earnings are now as dependent on household wages, salaries and broader personal income as at any time in recent memory. And corporations are continuing to pressure wages and salaries downward to protect margins and nominal profits.
Indeed, our current circumstances are so unlike any period in recent US history that economic signposts and markers of the last three to four decades may be quite misleading in the current cycle. Although it may sound crazy, part of our thinking must at least allow for some possibility that everything we've learned about economic cycles of the last half century will be wrong in this new decade of the millenium.
M O R E. . .
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