Market Commentary

Weekly commentary on recent stock market action, with a particular focus on technical analysis.

February 15, 2017

Scott Wren, Senior Global Equity Strategist

Stock Market Is Going to Be Laser-Focused on Wages

  • In our opinion, investors should be watching the pace of wage growth over the next handful of quarters to help gauge inflation pressure and potential Federal Reserve (Fed) action.

What it may mean for investors

  • Wage pressures might push the Fed to hike rates faster than expected in 2018. Those concerns would likely create headwinds for the stock market in the second half of this year.

You might have heard that the most recent push higher in the major equity indices was due to comments our new president made touting the coming announcement of “huge” tax cuts. These proposed cuts are just some of a number of pro-growth ideas that “might” or “could” come to fruition in the coming months or quarters (or years even). But that wasn’t the cause, at least in this strategist’s opinion. Sure, everybody likes a good tax cut that puts more money in consumers’ pockets, but a lot of cooperation needs to happen between Congress and the new administration before anything is enacted, and investors know that. We believe the rally of the last seven trading days can be traced to a precise moment in time: 8:30 a.m. EST on February 3.

How can we pin the catalyst down to that minute? It was the exact time the employment report covering January was released, and investors found out, within a few seconds, that average hourly earnings over the prior 12 months rose noticeably less than most analysts thought they would. For the last year or more, we have been writing about the importance of watching wage growth and how the Fed was keeping a close eye on this indicator. Fed Chairwoman Janet Yellen stated numerous times in recent years that she would like to see annual wage growth in the 3 percent to 4 percent range. Over that same time frame, she repeatedly noted that even though the unemployment rate was low (4.8 percent in January), there was still “slack” in the labor market. We have agreed. If the labor market was indeed “tight,” wages over the past 12 months surely would be rising at a pace quicker than January’s 2.5 percent reading.

So suddenly, and really without warning, the equity market seems to be paying attention to the rate of wage growth. Our 2017 prediction is that, after peaking in the middle portion of the year, the S&P 500 will fade in the second half. A big part of that forecast is our analysis suggesting investors are going to start to worry about higher wage (and general) inflation in 2018. Keep in mind that wages compose 70 percent of the cost to produce the average good or service in the U.S. So, in our opinion, if you want to predict where inflation is heading down the road, you need to understand what is going on with wages.

Of course, those worries would also be paired with fears that if wage growth edges up, the Fed might also be “behind the curve” and feel compelled to push through more rates hikes than anticipated to “catch up.” Stocks don’t usually react well to a Fed that feels the need to hastily push rates higher, especially when underlying economic growth does not seem to be keeping pace.

This strategist has argued for at least the past nine months that the most important number in the monthly jobs report was the year-over-year change in average hourly earnings, not the number of payroll jobs added and certainly not the unemployment rate. The Fed, per Janet Yellen, is watching this number closely. We think you should too because it appears that for the foreseeable future the stock market is going to be laser-focused on wages.

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