$240B Per Year Tailwind: Rising Wages Through 2017

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Includes: IYC, KXI, RXI
by: Adding Context

Summary

Average wage increase of 10% p.a. to lower income households through 2017.

Drives $240B of incremental value into the economy through either wages or productivity gains.

These increased wages could multiply and spur ~$400B per year of consumption by 2017.

Productivity investments (capital expenditures) will mitigate wage impact by reducing jobs.

Will be searching for equities to play this shift in capital.

Starting in 2016, rising wages may provide an important tailwind to support the next bull market. This trend has already started ramping up, but it will not be in full strength until 2017. In the current market conditions, I will be looking for buying opportunities that will benefit from greater consumer spending, rising inflation or increased capital expenditures as businesses attempt to offset rising labor costs. Additionally, I will be trying to avoid stocks that rely too heavily on low paid labor.

You probably heard the headlines in 2015:

Alone, these raises represent an ~10% wage increase for ~2% of our 140M+ non-farm working population. However, the increased pay at these organizations increases competition for other employers, including farming labor, which is ignored in a lot of the data. Therefore, one might assume that the coming 2 years could see a 20% (10% p.a.) increase in pay for the 45% of employees that earn less than $25k per year (Census Bureau via Wikipedia). With those numbers, we are looking at a raise on employees earning ~$1.2 trillion per year. Therefore, the coming pay increases may represent $120B+ p.a. increase in wages in 2016 and another $120B+ p.a. increase in 2017, or $240B per year by 2017.

If these wage increases were to materialize without job loses, the impact on consumption would be multiplied as more money enters the system, creating more wealth and jobs. EPI (left leaning) estimates that this multiplier is 1.5-1.75x. This multiplier is supposed to account for the propensity of a minimum wage earner to spend an incremental dollar after the impact of higher prices is considered. In other words, if a consumer spends money, it creates jobs for people that spend more money. Therefore, a dollar into the economy in general is worth more than a dollar. This multiplier is higher for lower income households, which are the most impacted by the wage increases. Therefore, pay increases of $240B by 2017 may increase GDP by ~$400B per year by 2017, or up to $15B+ per month. To put that into perspective, this is ~1/5 of the quantitative easing program after the 2008 crisis.

If this adjustment is true, the Bureau of Labor Statistics should be able to capture the change on their average hourly wage website. While January might just be noise as suggested by the Wall Street Journal, I am looking to see a continued increase in February to start the trend.

Of course, we operate in a dynamic economic environment. The impact of a wage increase like this will not all fall into consumption. Business leaders are going to finally decide to make the incremental investment into machines that reduce jobs. Should productivity be a significant mitigating factor, we should see a sustained jump in BLS productivity statistics in Q1 and Q2 of 2016, once businesses have had time to react.

Therefore, I will be looking for investment opportunities that might benefit from this tailwind:

Price inflation: Both the availability of money and the higher cost of labor will drive up prices on all of life's essentials (food, rent, etc…), potentially causing incremental inflation and impacting all stocks with strong ties to inflation

Increased consumption: While "price" might rise, it will be linked hand in hand with "quantity," therefore, I would be looking for increased units sold on stocks linked to consumption:

Capital expenditures: Businesses will spend money on investments that might drive productivity increases, allowing the use of less labor and mitigating the impact on wage increases that drive price and quantity above. Unfortunately, I do not yet have any good ideas to capture this spending. Here are some initial ideas:

In conclusion, the impending increases in wages for low income households are likely to create a tailwind for some companies. I will limit the scope of my investment search to companies that benefit from that tailwind. Clearly, I don't have the answers yet. I will be looking more deeply in the coming weeks and months. Please be sure to leave any additional thoughts you might have in the comments.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.