The Word from Main Street
Market Update for the Week of May 22, 2023
The overarching theme of 2022 was inflation and its economic impact. This has transitioned into 2023’s main theme of recession worries. While most acknowledge the concerns over a recession as reasonable, many point to the low unemployment rate coupled with an increasing labor force participation rate. Single economic data points have their respective issues; the unemployment rate is one of the most notorious in this regard, but there is still valuable information to be gathered from them. It’s tough to be in the midst of a recession when unemployment is low and labor force participation is ticking higher. From this point of view, it does seem like the economy is in great shape and things will continue to get better with inflation currently well off its 2022 highs. Of course, these two data points are insufficient to make broad assumptions about the economy moving forward. If anything, they raise questions that need to be answered.
Source: Nasdaq Dorsey Wright
One concern is the reason people are entering the labor force. There are both good and bad reasons this could be the case. For example, have wages risen enough for people to be incentivized to find a job, or has inflation done enough damage that people need to find jobs to pay their bills? In the chart below, one can see by the blue line that average hourly earnings have moved higher but have not kept up with inflation, shown by the red line. While there have been some months during which real wages have been positive, over the last roughly year and a half, they have been negative. This would suggest that while nominal wages have moved higher, it may not be the reason people are going back to work. Rather, the decline in real wages has forced people who did not have to work before to return to or enter the workforce. Another way to look at the decline in real wages is the Employment Cost Index which measures the change in the cost of labor. In the constant dollar format (real-dollar value), compensation costs have been negative over the last twelve months which means employers are paying workers less on a real-dollar basis.
So, while unemployment is low and labor force participation is ticking higher, real wages have been negative. This lends credence to the idea that people are going back to work out of necessity and not because of nominal higher wages. A counterpoint would be that while real wages are down, people still have their jobs and are earning money which they can continue to spend. While this is primarily true, employers have seen the productivity of these workers decline since the first quarter of 2022. As shown by the green line below, the year-over-year (YoY) change of labor for productivity has been negative for over a year now. Simply put, the increase in employment has been coupled with per-worker productivity declining. While real wages have been primarily negative and consumers can afford to consume less, employers have still had to increase nominal wages while getting less productive work in return.
Source: Nasdaq Dorsey Wright
If businesses/employers are paying people more to be less productive, then they have no real incentive to continue to hire new employees and may even resort to laying off current workers. Yes, real wages have been negative, but average hourly earnings have drastically increased relative to the last 15 years and contributed to higher labor costs. In the chart below, the YoY change in labor productivity and the unemployment rate are displayed. The only other periods when labor force productivity declined by more than 1.5% were during or preceding a recession in which unemployment then moved higher. The two other periods during which labor productivity declined more than 1.5% were in 1974 and 1982, which led to unemployment moving substantially higher, by at least 3%. While it’s difficult to estimate how much unemployment would increase, it’s much easier to say the conditions are present for businesses to stop hiring or begin laying off people, if they have not already. At the same time, consumers are not able to purchase as many goods and services since real wages have fallen. Furthermore, new workers are less productive and cost more, which puts extra strain on businesses that are now less likely to hire new employees and are more likely to either halt hiring or lay off existing employees. Economic predictions are infamously difficult to time (we believe this is where technical analysis shines); however, the economic conditions are less favorable than one would assume by simply looking at unemployment and labor force participation. At some point, the Pied Piper must be paid, but it’s unknown when and how much.
Source: Nasdaq Dorsey Wright
The current reading for the Nasdaq Dorsey Wright PR4050 Cash Trigger is: Money Market = 35.21% & U.S. Equity Core = 96.48%. For the PR4050 indicator to trigger and alert us when we should consider moving to cash, Money Market must be 50% or above and U.S. Equity Core must be 40% or below.
Source: Nasdaq Dorsey Wright
Below is the most recent DALI (Dynamic Asset Level Investing) Indicator showing International Equities maintaining the top spot, while Commodities, Cash, and Domestic Equities continue to battle for the remaining areas of emphasis.
Source: Nasdaq Dorsey Wright
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