Market Comment 16/03/2018
US Wage Growth & Potential Trade Tariffs
Hector Kilpatrick explains why we believe the fears that wage growth will accelerate to such an extent that interest rates will have to be increased materially more than currently expected, to counter inflation, are misplaced...
What a difference a month makes. The US stock market (S&P500 index) fell 8.5% in the five trading days following the release of January’s provisional ‘Average Hourly Earnings’ numbers on the 2nd February 2018. The reason most often cited for the collapse was that these numbers evidenced wage inflation in the US starting to accelerate and higher than expected interest rates would surely result. The fact that these numbers were provisional counted for naught.
...the unemployment rate did not fall as workers who had previously opted out of the labour market were seen to be returning, thus relieving the upward pressure on wages. Goldilocks, indeed.Fast forward to the 9th March when February’s provisional ‘Average Hourly Earnings’ numbers were released and, for those that want to, a completely different narrative could be spun. These numbers saw a revision down of the January ‘Average Hourly Earnings’ number and a surprisingly low provisional February ‘Average Hourly Earnings’ growth number, despite a surge in employment. Furthermore, the unemployment rate did not fall as workers who had previously opted out of the labour market were seen to be returning, thus relieving the upward pressure on wages. Goldilocks, indeed. Unlike other regional equity markets, the S&P500 index has (at time of writing on the 14th March) recovered much of the falls witnessed since the 1st February.
Concerning the employment and wage data, the truth, no doubt, will lie somewhere in between, but as we have previously communicated the linkage between wage growth and inflation is a lot less strong than some would seem to believe see our volatility article. We expect higher wages to drive productivity enhancing investment, which will help dampen economy wide inflationary pressures. As an example, we are increasingly hearing from company management teams that automation of repetitive white collar jobs is beginning to be rolled out. Indeed, a global bank recently told us that they have so far saved 1300 roles as a result of automation in their middle and back offices and that people ‘will be surprised how much further this can go’. Productivity enhancing investments such as these will cut across both the services and manufacturing sectors in the coming years.
The current proposed trade tariffs on imports of Steel and Aluminium to the US, in isolation, are irrelevant to the global economic outlook...
The current proposed trade tariffs on imports of Steel and Aluminium to the US, in isolation, are irrelevant to the global economic outlook, even if the imposition of these tariffs trigger responses from third parties which cover more products. The reason for this is that all sides will want to keep the ‘trade war’ contained to specified niches.
Much more problematic, however, could be the findings of the ongoing Section 301 investigation which has been tasked to ‘determine whether acts, policies and practices of the Government of China related to technology transfer, intellectual property, and innovation are unreasonable or discriminatory and burden or restrict US commerce’. It is expected that the outcomes of the investigation will be announced at any time between now and August. The results of this investigation could be far more meaningful, and harmful trade tariff actions from both sides could result.
However, it is instructive that, ahead of time, the US authorities have requested Chinese trade officials to come up with proposals to reduce their trade surplus with the US by $100bn; a third of the total. At the same time, there are tantalising hints of progress concerning the resolution of the Korean Peninsula’s geopolitical tensions.
Trump has, in the past, linked the two issues. It may, therefore, be wrong to treat these two issues separately and it is entirely possible, given Chinese pragmatism and national self-interest, that deals are done to sort out both issues concurrently. Chinese pragmatism was clearly in evidence when the country responded to the threat (from the US) of being designated a currency manipulator by supporting the Yuan to such an extent that this became a non-issue.
In our view, Trump is developing a track record of espousing extreme initial positions only to settle at more moderate levels later on. Any deal which meaningfully addresses the trade imbalance would be highly supportive to the outlook for US earnings.
Should no deal be forthcoming, expect the Trump administration to threaten tariffs on a multitude of products and restrictions on Chinese investment in the US.
According to CornerStone Macro (CSM), US custom duties on imported goods currently averages 1.6%. This is down from 4% in the 1980s and 7% in the 1960s. If a 10% import tariff on all Chinese imports were imposed by the United States, which was then replicated by China, CSM calculate the negative impact on US GDP growth would be just 40bp per annum and the inflationary impact would be circa 30bp per annum. Secondary responses such as a Chinese ‘weaker Yuan’ policy were not taken into account in this analysis.
Whilst the impacts on specific US sectors, both positive and negative, could be large, in aggregate, these are not game changing numbers. However, the difficulty lies in assessing what the impact would be on investor confidence.
Whilst the impacts on specific US sectors, both positive and negative, could be large, in aggregate, these are not game changing numbers. However, the difficulty lies in assessing what the impact would be on investor confidence. As demonstrated by the over-reaction to the provisional ‘Average Hourly Earnings number, some investors could well take fright only returning to the market once the dust had settled.
So, in short, we believe the fears that wage growth will accelerate to such an extent that interest rates will have to be increased materially more than currently expected, to counter inflation, are misplaced. As evidence of this builds, investors should start to refocus on the ongoing earnings upgrade cycle in the United States and this will continue to support equity markets.
So, in short, we believe the fears that wage growth will accelerate to such an extent that interest rates will have to be increased materially more than currently expected, to counter inflation, are misplaced.
However there are near term risks to equity market levels should the US Section 301 investigations into Chinese trade practises lead to a rancorous shouting match between the two parties. We believe that, ultimately, the Chinese will do just enough to avoid a full blown trade war and that the outcome will be ‘developed economy’ equity market positive, but the journey to this outcome could well be noisy and, if so, markets will be volatile as a result.
Chief Investment Officer