Wage Growth Advances But Remains Top-Heavy

Summary

• Wage growth for non-farm private sector workers through the end of October increased at a 2.82% clip--the strongest showing since the end of 2009.
• Wage growth for non-supervisory workers posted wage growth at a more modest 2.40% for the month at a 16% pay differential.
• Labor participation ratio remains glued below 63% since November 2013 at levels last seen in 1977-78, signaling an outsized uptick in corporate investment is not on the immediate horizon.

Admittedly, there was little outwardly spectacular about the October jobs report: The headline job creation total was largely on target with consensus estimates creating 142,000 private and 19,000 public sector jobs for a total of 161,000 jobs for the month. Upward revisions for both September and August added 44,000 jobs to the year-to-date total for an average monthly job count of 181,000 through October, slightly less than the 219,000 pace through the first 10 months of 2015 but nonetheless a strong and widely based display of the economy's continuing ability to create jobs.

Digging a little deeper into the report however we find that the labor participation and employment to population ratios were largely unchanged for the month at 62.8% and 59.7% respectively. Outside of March of this year when the former ratio managed a post of 63%, the labor participation rate has almost been glued below 63% since November 2013 and has remained well below the pre-December 2007 level of 66%, signaling an almost cross-the board consensus view that an outsized uptick in demand for goods and services in the greater economy requiring major changes to current labor mixes-not to mention forward investment in plant, structures, equipment or inventories-is not on the immediate horizon. As a consequence, year-over-year corporate earnings have declined for six consecutive quarters through the end of the 2nd quarter, a streak that started back to the 1st quarter of 2015. It was only in the 3rd quarter that the corporate earnings drought was finally halted with a 2.7% increase year-over-year. Earnings will likely remain under pressure for the foreseeable future given the current demand and low interest rate environment. Meanwhile, the unemployment rate nudged down slightly to 4.9% for the month as the number of unemployed dropped by 152,000 to 7.787 million-little changed on the month but an encouraging 2.50% slide on October 2015. With core PCE price inflation still in check at 1.7% through the end of the 3rd quarter, there is likely still excess slack in the labor force-a point acknowledged with the release of the September FOMC meeting.

Wage growth was the main attraction of the October jobs report, an economic indicator that is scrutinized closely by the Federal Reserve as it deliberates a second move on its next move on the federal funds rate since 2006. Are we seeing the beginnings of an uptick in inflation in the greater economy as more workers join-or rejoin-the labor force? Is the demand curve for goods and services actually shifting which would require corporate decision makers to expand labor mixes? Is there evidence of shortages of labor and/or skillsets in particular markets forcing companies to increase pay packets to attract the appropriate labor mix? Will stock buybacks programs give way to organic earnings growth?

Wage growth for all non-farm private sector workers shifted gears during the month; hitting a cruising speed of 2.82% year-over-year-the fastest pace since 2009 (see Figure 2, below). The driving force behind the increase was provided by outsized gains in productivity during the month which soared at an annualized rate of 3.1%. Output closely followed suit posting a 3.4% annualized rate while hours worked edged up a mere 0.4%. The productivity gains in the 3rd quarter were the best posts since April 2010.

Yet rather than capturing productive mojo of years past, much of the productivity gains owed to same surge in soybean exports that juiced GDP growth during the quarter as poor harvests in the world-leading soybean producer states of Argentina and Brazil allowed American farmers to almost unilaterally fill the global market gap. The one-off event likely makes the surge in productivity, as in GPD, less than sustainable in the 4th quarter and beyond.

Figure 1: Wage Growth October 2015-October 2016 in Hourly Private Non-farm Payrolls for all Employees by Industry

Industrial Sector	Number of Employees (thousands)	Percent Change of Employees YOY	October 2015 Hourly Wage	October 2016 Hourly Wage	YOY Percent Growth
Goods Producing	19,615	-1.16%	$26.38	$27.22	3.18%
Mining/Logging	678	-14.39%	$31.39	$32.56	3.73%
Construction	6,679	-0.515%	$27.51	$28.39	3.20%
Manufacturing	12,340	-0.66%	$25.46	$26.29	3.26%
Service Producing	103,102	1.64%	$24.94	$25.61	2.69%
Wholesale Trade	5,945.6	0.83%	$28.91	$29.75	2.91%
Retail Trade	15,992	1.48%	$17.70	$17.95	1.41%
Transport/Warehouse	4,919	0.54%	$23.02	$23.55	2.30%
Utilities	560.5	0.91%	$37.53	$39.10	4.18%
Information	2,781	0.40%	$35.47	$37.32	5.22%
Financial Services	8,336	2.03%	$31.70	$32.61	2.87%
Professional/Business	20,415	1.82%	$30.30	$31.07	2.54%
Education/Health	22,861	1.74%	$25.44	$25.89	1.77%
Leisure/Hospitality	15,565	2.18%	$14.45	$15.12	4.64%
Other Services	5,721	1.49%	$22.63	$23.19	2.47%
Total Private	122,717	1.18%	$25.21	$25.92	2.82%

Click to enlarge

What jumps out from the data on wage growth for the month is the disturbing lack of even distribution of such gains across industrial sectors. The range of the month's increase in year-over-year wage growth distinctly favors goods over service production-even though American households unsurprisingly spend more than twice the amount of income on services than they do on goods in any given year. Goods production commands about 16% of the private sector workforce and laid claim to an above average 3.18% of the month's private sector wage growth. The service sector, at 84% of the private sector workforce during the month took home a below average of 2.69% of the month's private sector wage growth. The percent gain of workers in goods production over the course of the year through the end of October actually fell 1.16% which spreads higher average wage levels amongst a shrinking sectoral workforce. Service jobs meanwhile increased 1.64% for the same period as wage growth averages are spread across a worker base that has about five times as many heads. Information and technology specialists had the lowest positive gain in jobs on October 2015 and claims the third lowest number of employees nonetheless secured the highest percent gain in base earnings for the month at 5.22%. The two lowest percentage gains in wage growth for the period were in education/health (1.77%) and retail (1.41%) experienced the fourth and fifth largest present year-over-year gain in job creation which comprises 32% of the total private sector workforce. Leisure/hospitality workers secured the second largest percentage gain in wages over the period at 4.64% but remain locked at the lowest overall rate of pay of any industrial sector.

Figure 2: Wage Growth October 2015-October 2016 in Hourly Private Non-farm Payrolls for Production and Non-supervisory Employees by Industry

Industrial Sector	Number of Employees (thousands)	Percent Change of Employees YOY	October 2015 Hourly Wage	October 2016 Hourly Wage	YOY Percent Growth
Goods Producing	19,615	-1.16%	$22.15	$22.79	2.89%
Mining/Logging	678	-14.39%	$26.65	$27.04	1.46%
Construction	6,679	-0.515%	$25.39	$26.24	3.35%
Manufacturing	12,340	-0.66%	$20.06	$20.62	2.79%
Service Producing	103,102	1.64%	$21.01	$21.50	2.33%
Wholesale Trade	5,945.6	0.83%	$23.80	$24.37	2.39%
Retail Trade	15,992	1.48%	$15.01	$15.01	0.00%
Transport/Warehouse	4,919	0.54%	$20.80	$21.10	1.44%
Utilities	560.5	0.91%	$34.53	$35.96	4.14%
Information	2,781	0.40%	$29.10	$30.45	4.64%
Financial Services	8,336	2.03%	$25.51	$26.39	3.45%
Professional/Business	20,415	1.82%	$25.01	$25.63	2.48%
Education/Health	22,861	1.74%	$22.27	$22.63	1.62%
Leisure/Hospitality	15,565	2.18%	$12.50	$13.00	4.00%
Other Services	5,721	1.49%	$19.14	$19.40	1.36%
Total Private	122,717	1.18%	$21.21	$21.72	2.40%

Click to enlarge

The wage growth of private sector production and non-supervisory employees tells a slightly different story (see Figure 3, above). With the exclusion of supervisory workers, wage growth for the month came in at a more modest 2.40% as hourly rates almost uniformly across the board fall on average 16%. Goods production still commands the better part of the month's wage growth at the above trend level of 2.89% while the service sector makes do with a below trend average wage growth of 2.33% for the period. Non-supervisory information and technology workers remain top seeded at 4.64% despite being just 0.023% of the private sector workforce or managing 0.40% jobs growth year-over-year through the end of October. On the other end of the pay spectrum, non-supervisory retail workers claimed no wage growth at all for the period while posting a 1.48% job creation rate year-over-year and comprising 13% of the private sector workforce during the month.

The lack of broadly based wage growth is reflective of a variety of current trends that appear to be keeping the Phillips Curve, or the inverse relationship between falling rates of unemployment and price inflation, largely at bay. An aging population and a shrinking labor force beget a proportionally shrinking consumer base that is increasingly met with an equally proportional decrease in corporate forward investment. The feedback loop directly impacts both share prices and growth at the corporate level and the prospects of economic growth in the greater economy as well. The grand and historically rapid shift from an older to a younger workforce brought on by a disproportionate number of baby boomers retiring from the labor force-a cycle that will not complete itself until 2029-can likely be expected to exert further downward pressure on wage growth for the period. Downward pressure on wage growth will also materialize from the continuing shift out better paying goods to lower paying service production. Similarly, the shift from permanent to temporary employment will also exert downward pressure on wage growth as companies adapt to continuing-and likely downward-shifts in demand in the greater economy.

The impact of these changes has already spilled onto the political landscape. Fiscal policy throughout much of the developed world since the financial crisis systematically kept government from playing the role of lender of last resort as economic growth contracted. Populist movements from both ends of the political spectrum stepped into the equation from the US to France to Italy to Germany to the Netherlands and Britain-upending the status quo by bringing mainstream voters into the fold whose expectations have been jilted under the weight these changes.

These are the issues that underlie the glue that have literally cemented the labor participation rate at ratios last seen in 1977-78. These are the very issues with which the Federal Reserve continues to grapple as it contemplates its next move on the federal funds rate at its December rate setting meeting.

That said, market expectations project a 68% probability of a 25-basis point increase to begin the New Year through yesterday's market close. It will take a tail event like a Trump victory in today's US presidential elections precipitated by lightening upward market adjustment of its prevailing risk premia - to squelch such a hike.

Analyst’s 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.