What Did We Learn This Week? (08/17)—Labor Shortage

Tim Pierotti, Chief Investment Strategist

Labor Shortage (08/17/2022)

Above is a chart of The Atlanta Fed’s Wage Growth Tracker. The chart illustrates the unprecedented wage inflation we’ve experienced in the last year or so as the US economy has emerged from the depths of the pandemic. As a market strategist, like every other market participant, I want to understand when this parabolic wage growth will top out and at how fast will it decline as the Fed raises rates and eventually actually begins the process of quantitative tightening. The equity market, as evidenced by the ongoing summer rally, seems to believe this chart is ripe to roll over hard and soon, which would be a powerful enough disinflationary force to allow the Fed to stop hiking rates. Remember, there are various drivers of inflation such as commodities, finished goods, services and rent (OER), but no component of inflation is more important to the Fed than seeing the current spike in wages dissipate. But before we can or should opine about the rate of this chart’s future decline, we need to ask ourselves an important question: why has this happened in the first place? Why do we have a “worker shortage” that has begotten this level of wage inflation?

This past weekend, I was with an old college roommate who is now an Endodontist, which means he performs root canals. From a demand standpoint, business for him is strong, but there is one major problem about which he and his fellow dental professionals commiserate: they can’t hire employees, at least not anywhere near wages they paid prior to the pandemic. Jobs that he once filled for $25 an hour are beyond difficult to fill despite advertising help wanted for the same job at $35 an hour. Additionally, what do you think happens when his current employees hear that the new hire is making more than they are? As you may have already guessed, he is hiring anyone remotely qualified and passing along the higher costs of his new and existing employees to his patients. It is the same story told a thousand times over in this economy. We now stand at roughly 1.8 jobs available for every job seeker and the issues are ubiquitous in service and goods producing industries from healthcare to air travel.

So what’s going on? The simple answer is that the working age population is simply not growing, and the labor market was already tight coming into the pandemic. As we all know, both the Fed and Congress provided powerful stimulus, arguably too much stimulus which created a spike in demand for goods and services. But it’s now August of 2022 and GDP is running somewhere around flat to up 1% and yet there is still no alleviation to wage acceleration.

Because the working age labor force isn’t growing, the participation rate is critically important. Unfortunately, the participation rate has been weaker than economists expected especially with the youngest and oldest cohorts. Even in the most recent NFP employment report that showed over 500,000 new jobs created, the participation rate actually declined. Given recent trend of disappointing participation rates, it seems unlikely that we are going to see a massive turnaround in older workers returning to the workforce. The spate of retirements and those retirees staying retired leaves us with a situation where businesses have a smaller and less experienced pool of workers to fill jobs.

That brings us to the issue of falling productivity. Jason Furman (former Obama economic advisor) and Wilson Powell from Harvard Kennedy School wrote last week that the recent declines in productivity, “are larger than the largest two quarter declines since the data began to be collected in 1947 – with the official estimate nearly twice as large as the largest previous decline.” On the Sysco Foods earnings call last week, the CEO Kevin Hourican said that though the company’s supply chain operations are now fully staffed, half of those employees have been with Sysco for less than a year. “And it’s that point, that point alone that results in a productivity rate that is below our historical average. These are challenging jobs. They’re skilled labor positions, and it takes time for someone to move up the productivity curve.” In fairness any economist will tell you that productivity is erratic and hard to estimate, but it seems clear that we are going to be dealing with an issue where less experienced workers are replacing more experienced workers while demanding higher compensation for less output. That is not a great setup for inflation to say the least.

The last factor that I believe is driving our current labor shortage is constrained legal immigration. As Blackrock’s Larry Fink recently said, “We’ve eliminated a large component of legal immigration. One of the reasons why we have such job needs, we have ten and a half million job openings right now and five million unemployed. So, we have a mismatch”

To conclude, we have several structural factors that have led to the problematic tightness in the labor market and in my opinion, the idea that these factors will fade away without an extended recession is wishful thinking.

Tim Pierotti is WealthVest’s Chief Investment Strategist. 

Tim has over 25 years of experience in various aspects of the equities business. Prior to joining WealthVest, Mr. Pierotti spent seven years in Equity Research management roles at Deutsche Bank and most recently at BMO where he was a Managing Director and Head of US Product Management. Tim has 11 years of investment experience most notably as Head of Consumer Research and Portfolio Manager at The Galleon Group, a former NY based $8Bln Long/Short hedge fund. Tim is a graduate of Boston College and lives in Summit NJ.

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