Macro Outlook

In the spirit of the upcoming holiday in the United States, we cannot help but think of a fireworks-related metaphor for the current equity markets. While we would love to say it has shot up like a bottle-rocket, or has been as spectacular as an aerial burst from a roman candle, it would be overstating it. No, the equity markets continue to act like a snake. For those who have spent less time with these consumer-grade incendiaries than us brash Americans, a “snake” comes in the form of a small black pellet that emits a long, brittle carbon ash when it burns resembling a snake coming out of the ground. If the description sounds unexciting, it’s because it is. And so has been the summer equity market. This week posted yet another slow grind higher roundabout 1%. String 52 of those together and we would have something to write home about, but alas the market has yet to go straight up at that pace – though the past two years have certainly felt a bit like it.

On Thursday, there was a bit of good news in the US labor market. Non-farm payrolls were up 288k in June. A strong print and one that finally puts the employment number back above the pre-recession peak (see the chart below). As the labor market slowly tightens, wage pressure is likely to follow. In fact, this has already begun. In the same employment report, they noted a 0.2% month-over-month gain in June. This continues a trend from the past 18 months or so. Wage growth year-over-year is over 2% at this point and is likely to continue to grind higher. There are two primary impacts we are watching on this front. The first is an effect on interest rates. With the Fed set to finish their taper next year and an interest rate increase well telegraphed for 2015, firming wages are a sign that economic strength is present for more “normalization” of real rates in the earlier part of the year – especially if increasing wages flows through to inflation. The second effect we are monitoring is on profit margins. US profit margins remain elevated given the productivity gains of the post-crisis period. As the number of employed and the wages paid increase, there is likely to be flow through to margins which would be a headwind to earnings growth.

Source: Strategas