Look, it was no secret that the May employment number would not be good. C'mon, employment has been the standout "what's different this time" characterization of the current cycle, hasn't it? I've been talking about the whole economic slowing theme for well over a few months now and all the anecdotal economic stats point to continued slowing. For now. Surprise over the employment stats? There should have been little. Anyway, as always, it's what lies "underneath the hood" that's the most important information, not the headline. I do not want to regurgitate broader analysis of the May employment numbers, but hopefully link what we're seeing within the employment report to larger financial market and economic themes important in the current cycle. Let's get right to it.
As always, probably nearest and dearest to my hearts is the character of wages, especially now that even core inflationary pressures are heating up. Remember, it’s important to key in on the service sector as this is by far the bulk of employment in the US (over 80% of the workforce is categorized as "service"). As is asked in the top clip of the chart below, is the year over year rate of change in service sector wages bottoming for the current cycle? I certainly hope so, but for now the year over year acceleration has been occurring for a whopping two months, hardly a trend. So stay tuned and keep your eyes open. But what certainly is important to the immediacy of our lives and near term investment decision making is what you see in the bottom clip of the chart - the year over year change in "real" service sector wages (I adjust using CPI data).
If we look at the year over year change in service sector wages and deflate the numbers using the CPI data, you can see that we're seeing negative real wage growth over the last four months. Important why? Although this is not a completely rare occurrence from an historical standpoint, it is the first time we've seen this in the current cycle. And it's happening at exactly the time we're now seeing macro economic slowing. If we back up and look at historical experience for just a minute, there is an important theme here. You can see that real US service sector wage growth fell into negative territory in late 2003 through early 2006. At the time the financial markets and economy marched to ever higher highs. But importantly we need to remember that this was the exact period of historic household credit expansion. Did credit expansion "offset" negative real wage growth at the time? In good part this was exactly the case.
We next see that negative real wage growth occurred across the bulk of 2008. Of course during that period household credit expansion hit a dead end and began the process of reversal. The financial markets and economy were likewise in the process of descending. Maybe it's a bit unfair to compare and contrast these two periods in isolation given the macro credit implosion of the 2008 period, but certainly a household sector facing negative wage growth was in no position to deleverage their collective balance sheet in any meaningful manner. As you already know, the household deleveraging process continues to this day with quite a road still to travel yet ahead of us. So now we find ourselves one more time in the midst of negative real wage growth domestically. Important question being, what lies ahead?
Let's look at one more quick relationship. Below we're again looking at the character of real service sector wages in the top clip of the chart below, but this time the comparator in the bottom clip is the S&P retail index.
Although I've once again colored with green bars the periods of negative real wage growth, let me draw your attention now rather to the periods of positive real wage growth that are not shaded in at all. From mid-2000 until early 2003, the S&P plummeted, dragged lower in very good part by the tech wreck and NASDAQ implosion fallout. But wildly enough if you mark the S&P retail index from mid-2000 until late 2002/early 2003, the price drop just was not that big a deal on a comparative basis - maybe 15+%, but not even close to the like period S&P decline, to say nothing of the NASDAQ. Maybe not too surprising is that over this same period real service sector wage growth remained in positive territory throughout. A support to consumption and the retail stocks that represent that consumption? You bet. Of course the other periods of positive real wage acceleration were likewise met with a positive S&P retail index price response. Given that we're once again looking at negative real wage growth, naturally it's time to watch the retail sector as a key indicator.
Have a quick look at the final chart of retail related equity below and I'll have a few comments.
To mix it up just a bit, above I’m using the S&P retail index ETF that is the XRT. The chart looks at the relative performance of the retail index versus the S&P back a few years. Without question retail has been one of the strongest equity sectors of the current cycle. In nominal price terms the S&P retail index went to all time new highs early this year. But given the trip into negative real wage territory that we've now embarked upon, retail now becomes a key sector to watch. Although I will not drag you through another chart of retail as I've covered it many a time in the past, please remember that retail sector relative and nominal equity price performance has led the broader equity market averages at important inflection point peaks and troughs over the entirety of the prior decade. Retail peaked before equities broadly in 2000. Retail bottomed in late 2002 and again peaked in early 2007 ahead of the broad equity pack on both counts. Finally, the S&P retail sector saw its lows for the prior cycle in late 2008 prior to equities broadly in early 2009. I believe it's fair to draw the linkage that if negative wage growth influences the direction of retail equities, this will have implications for the broader market.
What you can see in the chart above is consistent retail equity sector out performance over the entirety of the current cycle, but as the RSI and MACD indicators caution us, at each major relative price performance peak over the 2010 to present period, relative price performance momentum has been declining. It's a divergence of note. So, as we move ahead we need to watch both the nominal and relative price performance of the S&P retail sector as perhaps a key "tell" for equities broadly in terms of forward direction. The fact that we're experiencing negative real wage growth simply puts an exclamation point behind this comment.
Before moving along, one last issue regarding retail and household consumption in general. You also know that the recent Conference Board consumer confidence number for May reported a few weeks back was not too pretty a sight to behold. Again, this should have been absolutely no surprise at all to anyone. Of course this leads us to yet another data point of the moment very much worthy of monitoring given its historical linkage both to equities broadly and importantly to consumption within the context of a negative real wage gain environment. Right to the point, it's time to watch the "future expectations" component of the headline consumer confidence report.
Below we're looking at exactly the history of the future expectations numbers in the top clip of the chart set against the S&P 500. And this is important why? At least as per our experience in the prior economic and financial market cycle, it's the future expectations component of the headline confidence numbers that led the S&P downward in the last cycle. The directional divergence between the two was a key market divergence point at the 2007 S&P highs. For now, and although it's only four months of data, we're again seeing a directional divergence since February of this year between the S&P and the future expectations component of the confidence survey. This could easily be related to higher gasoline prices in 2011, but this remains to be seen in the confidence numbers over the months ahead. Again, at least as I see it, this also relates back to the key macro investment issue of recent economic slowing being temporary or otherwise. Up until February of this year the future expectations reading had been "following" the direction of the S&P since the lows of 2009. That all changed in the last four months.
Certainly the reason this linkage is important is embodied in the bottom clip of the chart above that is again the futures expectations confidence numbers this time set against the year over year change in real personal consumption expenditures. In very good part, these two data points have been directionally joined at the hip historically. As we again contemplate the relationship between the future expectations component of the confidence survey and the S&P, it's now clear this linkage relates directly to the key economic fundamental that is consumption. As we try to assess the very important near term macro that is temporary versus elongated macro economic slowing, keeping an eye on the confidence numbers will be very important. And finally, tying this back to the first comments in this discussion, negative real wage growth over the last four months is an important character point change in the current cycle we have not yet encountered up to this point. Does this negative real wage growth have the ability to influence confidence, consumption and ultimately both specific retail sector and broad equity market direction? If history has anything to say about it, indeed it does. In putting together a set of recession related leading indicators add the character of real domestic US wage growth, relative performance of the S&P retail index and the future expectations component of the consumer confidence report to the toolbox of macro economic monitoring.
