Someone is wrong on the internet, wages and the stock market edition

You may have heard that share prices are generally a bit lower now than they were a week or so ago.

One argument is that the drop was precipitated by the release of American job market data on Friday. Average hourly pay was reported to have grown by 2.9 per cent over the previous year — the fastest pace since June 2009. The thinking is that this will necessarily lead to faster consumer price inflation, or at least to Federal Reserve tightening in response to the fear of faster inflation.

Torsten Slok, Deutsche Bank’s chief international economist, gave a good summary in a recent note to clients:

The market has been worrying more and more about an overheating of the economy. That is why rates have moved higher. And these fears culminated on Friday with wage inflation hitting a post-crisis high. And it is the threat of higher inflation and higher rates that is worrying the stock market because higher wages means lower profit margins and higher inflation means faster rate hikes from the Fed as the FOMC tries to slow down the economy and ultimately the revenue growth of S&P500 companies.

Leaving aside the historically weak linkages between changes in nominal wage growth and changes in the rate of consumer price inflation, the bigger problem is that the latest figures do not actually validate what traders are thinking.

First, here’s some context on the “post-crisis high” reading:

The spike in the claret line at the end merely offsets the sharp drop in October and November. Slightly smoothing the series (the pink line) makes the latest figures look unremarkable. Taking a six-month average actually implies wage growth has slowed ever so slightly since the second half of 2016. The Employment Cost Index — a comprehensive measure including benefits and adjusted for compositional effects — also has shown no real change in the growth rate in the past few years.

There are also reasons to wonder how much of the reported wage growth is going to actually flow through to consumer spending. In general, people on lower incomes tend to spend more and save less, while those who earn more tend to save proportionately more of their income. Those worried that greater rewards for workers will boost consumer purchasing power and erode margins should therefore focus on the lower-paid sectors, such as leisure and hospitality. But wage growth there has been slowing down. (To be fair, the picture for healthcare and education looks better.)

More generally, the chart above is based on data for all private sector employees. For a much longer period of history, the BLS only tracked pay for “production and nonsupervisory” employees. About 82 per cent of all private-sector employees are currently considered “nonsupervisory” according to the BLS, including accountants, doctors, and lawyers. The pace of their wage gains has shown no accelerating trend in the past four years:

To the extent there is more of an upward trend it is being driven by the 18 per cent of the workforce in managerial positions.

Moreover, much of the difference between the two series can likely be explained by the financial sector. As Matt Boesler first pointed out, there is currently a yawning gap between the pay gains of the working stiffs and those closer to the trough in that sector:

Considering how the markets had been doing in the few months leading up to the BLS survey, it is not surprising that investment bankers and traders would have been recording large average pay increases. The FT recently had stories about how 2018 was shaping up to be a banner year for both IPOs and M&A.

It would certainly be ironic if financiers convinced themselves to sell stocks because of a single data release, which had been distorted by their own aggressive pay packets, which in turn were based on a market melt-up partly justified by the stability of inflation…