Why A Slower Pace Of Job Gains May Mean A Stronger Economy

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Summary

Job gains reported by both the BLS and ADP have showed a downtrend in the number of new jobs created over recent months, and data have disappointed in recent days.

However, rather than seeing this as a negative, could we actually see this as a potential positive?

If a tighter labor market means companies are able to find fewer qualified workers at the wages on offer, perhaps they might raise wages to attract talent on the sidelines.

Of course, higher wage gains can mean both higher consumer spending and higher inflation, which may mean the Fed could move faster than markets currently expect.

The caveat - and alternative explanation - is that the new administration may bring more uncertainty, a risk cited by Janet Yellen, causing companies to hold off on hiring.

A tighter job market may mean fewer job openings get filled

The Bureau of Labor Statistics reported 156,000 new jobs were created in December. This continued a trend of lower job gains since June 2016 and was a bit below expectations. Additionally, this followed the ADP payroll report in which we see private employers added 153,000 jobs in December, below expectations of about 168,000 and notably lower than the 215,000 new jobs added in November. Should investors treat this as a sign that the economy might be slowing? Maybe not. Particularly as it may coincide with the country being closer to full employment, creating a situation where qualified workers are harder to find. That could drive up wage gains for companies vying to attract talent - especially those who are currently on the sidelines - sending inflation higher and the Fed into quicker action.

One hint that employers might be having trouble filling jobs comes from data from the Bureau of Labor Statistics in the form of the Jobs Openings and Labor Turnover Survey, or JOLTS report, as it is commonly known. Typically, there are more new hires than published job openings because companies may fill jobs with people they already know, rather than inviting complete strangers to interview with them.

However, since the end of the recession, job openings have risen at a much faster pace than actual hires, suggesting that employers may be having difficulty filling those open positions. And for the first time since the records began in 2001, job openings have exceeded hires, with the difference between job openings and new hires illustrated in the nearby graph.

Is there a "skills gap"?

Some have purported there is a "skills gap," where would-be workers aren't qualified to fill openings. We can see this in other data, such as from the National Federation of Independent Businesses, which publishes a monthly survey of its small business members.

In it, we learn that 31% of all small business owners reported job openings they could not fill in the current period, up 3 points and the highest reading in this recovery, according to the organization. Sixteen percent of companies surveyed ranked the inability to find qualified workers as their top concern, not surprising given that 52% of the companies surveyed reported few or no qualified applicants for the positions they were trying to fill.

Can a tighter job market mean more wage gains?

One takeaway is that, eventually, payroll gains may slow as fewer qualified workers are found. At some point, this may lead to a greater competition for labor, prompting a faster pace of wage gains. Indeed, in today's payroll report, average hourly earnings increased by 0.4% from the prior month and by 2.9% from a year ago - the fastest pace in 2009. In turn, that might lead to stronger consumer spending and that can mean a virtuous circle of economic growth. It can also potentially lead to more inflation, encouraging a faster pace of rate hikes by the Fed.

We are also already seeing a rise in real (inflation adjusted) wages, as seen in the nearby graph. While some have lamented that wages are growing slowly, when one nets out the effect of low inflation, wage gains have actually been stronger now than in earlier parts of the millennium.

What is one general investment theme?

If sustained, we may be in what might be termed a "reflationary" environment, benefiting companies that can profit from higher prices received relative to the costs they pay (and that would include labor costs). Other relative beneficiaries may be those that might be less interest rate sensitive. Some companies, such as certain financials, may even benefit from a bit higher interest rates, as long as they can earn more of a profit from lending at higher (usually longer term) rates and borrowing (such as from depositors) at lower short term rates. This net interest margin has decreased in recent years, as seen in the nearby graph, and an uptick in this difference between lending rates and borrowing costs may be welcomed by banks.

Thus, a slowdown in employment gains may not be a concern at this point in the business cycle. We might even welcome the fact that a tight labor market can lead to higher wages and, as such, more consumer spending. Since consumer spending growth has been softer in this expansion than in earlier decades, anything that can propel the economy forward would be welcome.

Of course, that may mean higher borrowing costs, which can take some of the luster off the economy's shine. And these factors may be complicated all the more by an unfamiliar new administration.

One important final caveat

And that leads to a final caveat: uncertainty may continue to prevail, and that can prevent the economy from roaring ahead. And just as it led Fed Chair Janet Yellen to observe in the press conference following the most recent Fed meeting, "We're operating under a cloud of uncertainty at the moment," companies may similarly hold off on filling those open positions, or investing in new equipment, until that cloud is lifted.

Disclosure

Investing involves risk, including possible loss of principal, and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. The information contained in this piece is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. Please contact your financial adviser with questions about your specific needs and circumstances.

The information and opinions expressed herein are obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital. Opinions expressed are current as of the date of this publication and are subject to change. Certain statements contained within are forward-looking statements including, but not limited to, predictions or indications of future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. Indices are unmanaged, do not consider the effect of transaction costs or fees, do not represent an actual account and cannot be invested to directly. International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and different accounting methodologies.

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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. I have no business relationship with any company whose stock is mentioned in this article.

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