PRODUCTIVITY AND THE STOCK MARKET
With all of the problems I have been having with my internet connection I may have missed it, but the revisions to second quarter productivity did not seem to have been covered very well.
But nonfarm productivity growth is slowing sharply. It was actually negative in the first and second quarter —0.6% and -0.7% in the first and second quarters, respectively — and the year over year change is now only 0.7%
Moreover, productivity lagged two quarters is a great leading-concurrent indicator of real GDP growth. Productivity growth now implies that the second half will be weak. This is in sharp contrast to the still consensus expectations of a stronger second half.
With weak productivity growth, unit labor costs is moving up sharply. Moreover, the increase is due almost exclusively to the weak productivity, not rising compensation.
Unit labor cost is now rising more faster than the nonfarm deflator. The spread between unit labor cost growth and price growth is a primary determinate of profits growth and it is saying
that profits expectations are still too high– Standards and Poors, for example, is still carrying
a bottoms up forecast of some 20% EPS growth for 2011. The recent stock market volatility
— it’s interesting that stock market is only volatile when it is declining, not rising — appears to stem largely from investors revising their earnings expectation down. Moreover, the productivity data implies that this downward revision is not over.
Mike Panzer at Financial Armageddon has been on the issue that the “street” is missing all that is going on around them. From his blog: http://panzner.typepad.com/
However, I wonder if a new paper, “From Keeping Up with the Joneses to Keeping Above Water: The Status of the US Consumer,” from the BlackRock Investment Institute,
If long-term leverage sustainability is assumed to reside near 1990 levels, then the bulk of the deleveraging process remains ahead of the American consumer, regardless of the income measure used…
We think that these trends, coupled with stubbornly high unemployment, higher commodities prices, and slower growth in wages and salaries, will likely contribute to a lower level of personal consumption growth over the next few years. Moreover, since consumer spending is a key component of the GDP growth rate, this would argue for generalized economic growth levels that are, at best, modest for years to come, and may in fact appear anemic when compared to pre-crisis growth rates.
I have believed for years that the US is following the Japanese model.
But note that while the general belief is that the Japanese government policy has not stimulated the economy, the alternative might very well belief that Japanese policy may be preventing a depression.
Of course, the distinction between unit labor costs rising due to a drop in productivity and due to a rise in labor compensation is the difference between weak growth and strong growth. Strong growth argues that labor costs will only be controlled in the near to medium term by slowing growth. Weak growth argues that hiring will weaken, keeping compensation growth weak and stemming the decline in productivity and the rise in unit labor costs.
spencer, I believe you have pointed out in the past that falling productivity not only leads weaker GDP growth, but also weaker hiring. We are getting some of that now.
The position I have been taking with my clients is that in the extremely low wage growth economy we are experiencing the system can not sustain accelerating inflation. Currently, rising inflation leads to weak real income growth and weak consumer spending rather than an inflationary spiral.
If profit margins are being pressured by rising unit labor cost firms are likely to try to offset this with higher prices that in turn will lead to a weaker economy and even worse profits growth.
The surprise to me is that unit labor cost is rising as strongly as it is. Given the excess capacity that we see in the economy and the strength of productivity in the early part of the cycle, I did not expect to see the sharp cyclical slowdown in productivity this soon.. But the process seems to be that strong productivity has lead to weak employment and real income growth that in turn generated a weaker economy and even weaker productivity. It is a vicious cycle.