By Jeff Weniger
I still think of the market shock a few weeks ago when the Nonfarm Payrolls report showed an increase of 467,000 jobs in January, well ahead of the 150,000 expected by the market.
I won’t be surprised if this report is a taste of what’s to come in the coming months, as I contend this may be the hottest job market of my career.
Wage inflation and a pinch in the profit margin is the assumption.
As we get to the charts, think about what has been working in the stock market lately. Since November, bears have come after stocks with distant cash flows whenever rates have risen, due to the calculations behind discounting future values to the present. By contrast, companies that are currently profitable – many of which are in value indexes – have held up.
It’s something like this:
Inflation “on” → More Fed hikes → Value stocks beat growth
Inflation “off” → Fewer Fed hikes → Growth stocks beat value
Figure 1 shows the steady rise in the dropout rate in the United States over the past two years. People give up their jobs when they are convinced that they can find new ones. Importantly, the biggest pay raises often come when you step into a new company – and that’s exactly what a lot of people do.
Figure 1: US JOLTS survey, dropout rate
Their confidence stems from basic arithmetic. We had a few years before Covid when, for the first time in generations, there were more vacancies than unemployed.
The lockdowns put an end to that.
But 2022 is not 2020; job vacancies again overtake the ranks of the unemployed, this time by a country mile (Figure 2).
Figure 2: JOLTS survey, total number of job vacancies minus total number of unemployed (thousands)
Figure 3 shows another way of looking at things. As hot as the 2018-2019 labor market is, this one far exceeds it.
Figure 3: US job vacancies as % unemployed
You can glean a lot of labor market insights from the National Federation of Independent Business (NFIB) survey. In January, the most recent report, 47% of small businesses reported having one or more hard-to-fill jobs (Figure 4).
You know the old saw? “The cure for high commodity prices is high commodity prices.” If copper explodes, miners mine more copper, driving the price down.
Well, if you post a job offer and you can’t find anyone, the solution is to raise the salary. Candidates will appear…once you change the compensation.
Figure 4: NFIB survey: “1 or more hard-to-fill jobs”
The same NFIB survey shows that 50% of employers were actively increasing compensation by the end of 2021, with 27% saying they intended to do so in the coming months (Figure 5).
Figure 5: NFIB Survey, Workers Compensation
The Atlanta Fed’s wage growth tracker showed a 4% year-over-year increase in January. I suspect it is headed higher (Figure 6).
Figure 6: Tracking Atlanta Fed Wage Growth
In the wake of the latest inflation report, which recorded a 7.5% year-on-year rise in the consumer price index (CPI), the futures market for Fed Funds now expects the policy rate to be north of 1% by summer (Figure 7).
Figure 7: Federal funds rate probabilities, July 2022 FOMC meeting
The good news is that I think the labor market is going to be so hot that the Fed won’t break the back of this economy yet, at least not in 2022. The bad news is that we could be in for a shower of profit margin warnings .
Since return on equity (ROE) calculations are a function of profit margins, the way to figure it out is to pick companies that can give staff a raise without the black ink turning red.
I did something new in Figure 8. By dividing ROE by P/E, I found a quotient that will put into context how much baskets of high quality stocks will cost you. The WisdomTree US Value Fund (WTV) scores particularly high, 1.69. This may be the one to use if you have a theory that inflation is pinching profit margins.
Figure 8: ROE vs. P/E
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Jeff Weniger, CFA, Head of Equity Strategy
Jeff Weniger, CFA, is head of equity strategy at WisdomTree. Jeff has a background in fundamental, economic and behavioral analysis for strategic and tactical asset allocation. Prior to joining WisdomTree, he was a Director, Senior Strategist at BMO from 2006 to 2017, serving on the Asset Allocation Committee and co-managing the firm’s Model ETF Portfolios. Jeff holds a BS in Finance from the University of Florida and an MBA from Notre Dame. He is a CFA charterholder and an active member of the CFA Society of Chicago and the CFA Institute since 2006. He has appeared in various financial publications such as Barron’s and the Wall Street Journal and makes regular appearances on the Business News Network (BNN ) from Canada. and Wharton Business Radio.
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.