As We’re Waiting On Wage Growth, Here’s The Conversation No One Sees Coming- By NEIL SISKIND

As losses on the S&P 500 Index, the Dow Jones Industrial Average, and the Nasdaq mount, investors and the media continue to ask, “Why?”.

So … why are these declines happening?

The declines are due to concerns about slowdowns in the economy and in earnings due to the combination of rising interest rates, elevated oil prices, rising consumer product prices due to tariffs, excessive corporate and government leverage, slowing exports, the approach of the natural end of a long business cycle, and stagnant real wages. So- there is no one reason for the declines[1]. These concerns are leading to investors selling equities and moving capital to more defensive positions, including into cash.

It’s not the lack of animal spirits in the U.S., or a lack of liquidity that are of the causes of concern about the underling economy at this time, or even over the course of the next six months, even as interest rates “normalize” and as the Fed searches for a rate it deems to be “neutral”. It’s the geopolitical policies and constraints that are being laid atop the rising target Fed funds rate (and the related interest rates) that are pressuring markets and investors to face concerns that, otherwise, would, likely, because of the fiscal stimulus, need not be addressed until mid to late 2019. Geopolitical risks are unpredictable and difficult for businesses and consumers to plan around or quantify.

Growing costs from the combination of tariffs, interest rates, and energy prices, are not new costs only for businesses– consumers’ costs have also been rising due to the same factors- and all in the face of, largely, stagnant wages- and it could begin to affect revenue growth results in Q3 and/or Q4 of 2018, and in 2019. Investors are wondering where Q3 earnings and/or Q4 guidance will fall. Investors are concerned about revenues- and about margins.

When it comes to higher costs, investors and analysts have been asking whether businesses that are experiencing higher raw materials costs will take the margin hits, or pass the costs on to consumers. They forget to discuss the third option: businesses can cut other costs, to wit, labor, to avoid either eating the margin losses or raising their prices. Hiding behind the conversation that this nation has been having about wage growth is a completely contrary conversation waiting to reveal itself- one about layoffs.

Because of the growing and new expenses for businesses and consumers with which businesses must contend, revenues and profits are at risk. What can businesses do about lower profit margins[2]?

Can businesses reduce tariffs? Of course not.

Can businesses reduce the prices of oil and gasoline[3]? No.

Can businesses have the Fed reduce its target funds rate- or can businesses make the 10-yr. Treasury yield decline? Not likely.

Here’s what businesses can do. They can cut expenses and reduce overhead- by cutting jobs.

Not only will job openings decline if revenues continue to disappoint while expenses rise- so will existing jobs. (Paradoxically, even following layoffs, the number of job openings still may not decline in a significant way. This could occur if the jobs needed to be filled are those requiring rare and special skills. Such positions can remain open even upon layoffs, and may remain open and unfilled until the skills gap narrows, which could take years.)

Everyone has been wondering for months- actually, for years- where the wage growth is. Perhaps, it’s time to begin to wonder, instead, when the job cuts will come. People have been discussing how higher labor costs would affect businesses if wages start to rise in response to low unemployment, as the Phillips curve suggests; but no one goes on to the other potential conclusion- that companies don’t have to give raises if the unemployment rate declines. The Phillips curve- if it even lives- is a concept, or a “theory” (one that, in the age of globalized work forces, and in a time where larger and larger companies dominate, if not nearly monopolize their industries, takes longer and longer to take hold)- and not a law that demands raises. One common way that wage pressures are managed by businesses- like any other costs- is to cut them- with the remaining employees forced to pick up the slack. In times of slowing-growth, labor forces are strictly scrutinized to eliminate any of the slightest redundancies. Demand destruction takes place in labor markets as in any other markets where costs rise too high to be sustained by those paying them (especially as other costs also rise, or revenues slow). Even if wages rise temporarily due to labor supply pressures, they can also be the first thing to get cut as revenues and/or earnings decline.

I’ve written in the past that there is good inflation and bad inflation- and that the “timing” of the inflation makes it one or the other. Rising wages can be good, if they are accompanied by GDP and earnings growth, but not if they are running counter to such growth patterns- and certainly not if, in addition, other input costs are rising. This latter type of scenario does not lead to raises and bonuses- it leads to layoffs. While everyone has been waiting for wage pressures to materialize, all sorts of other cost pressures have appeared. Companies cannot pass them all through to consumers- or absorb them all.

We are in a jobs bubble, one fueled by monetary and fiscal stimuli; and like a stock, or housing, or any other bubble, it eventually pops when the financial underpinnings are exposed … and usually long before it’s expected or predicted. If businesses foresee growing costs in the pipeline, or the potential for lower revenues, they have to be pro-active, and not re-active, especially in public companies, where officers’ jobs depend on profitability, and even on stock growth. Layoffs should come as no surprise as the GDP declines- as everyone anticipates. As job losses mount and demand side stimulus contracts, the slowdown is exacerbated.

Could anyone really think that if interest rates rise, and stocks fall, and housing markets slow, and trade wars and related costs grow, and GDP declines, and export markets contract, and sanctions cause higher oil and gasoline prices for consumers and companies, and government and corporate debt levels inflate- people won’t lose their jobs? Unemployment is just one more liquidity-fueled bubble, like any other liquidity-fueled bubble, which gets resolved, among other ways, by the withdrawal of liquidity by the Fed. Except in this case- it’s not only the Fed, but also the White House that will help ensure that the bubble deflates- or pops- much sooner than later.

If earnings and/or guidance over the next couple of weeks disappoint, and companies, by and large, point to rising input costs from interest rates, oil, and/or tariffs as the causes- the conversation on your television and in the markets will soon be changing from one about “waiting for wage growth”- to one about “preparing for layoffs”. This would not take place until after the holiday season, including the January “gift return and exchange” season.

If, and as the economy slows, a military standoff or conflict might arise between the U.S. and China. Military conflicts often occur in slow economic times to distract people, to rally the citizenry through patriotism, and even to create jobs. Regardless of the potential for such ulterior motives, tensions with China are on the rise and could escalate in coming months. The trade war would be a secondary cause for any military conflict, with the primary impetus being the United States’ encroachment on Asia, as the U.S. and China continue to compete behind the scenes for the soul of Kim Jong-Un and North Korea, and as U.S.-Taiwan relations expand. Kim Jong-un’s effect on world politics and global instability will rise in 2019. Russia’s location, and, thus, interests in the region will draw it into the conflict. How this will affect the U.S. economy is, of course, an unknown- and something for which investors should prepare as best as possible by watching commodities and currencies as events begin to heat up. All the pieces are in place for tensions with China to escalate in the coming months- as the trade war is taking its toll on the Chinese economy, as Kim Jong-un continues to be used as a political pawn by the U.S. and China- and as he plays both ends against the middle, and as U.S. Navy warships are flaunting their strength in the Taiwan Strait. Does this sound like a blossoming friendship to you? In general, the present administration is determined to repress China’s rise as a (or as the largest) superpower, at any cost- as we have been witnessing on the trade front.

For now, the unemployment rate and jobless claims remain low; and job openings remain high and continue to go unfilled, while the CPI, the PCE, the household savings rate, consumer spending[4], and real wages are all, basically, stagnating. Personal wealth is declining as housing and stock prices are under pressure. Household debt is at an all-time high. Company revenues and margins are under pressure in many sectors. As the U.S.’s, China’s, Japan’s, and other nations’ consumers spend less on U.S. products, how can companies’ earnings grow?

All that can really be said about consumers in terms of purchasing power is that they have jobs. This is pretty much what any and all bullishness on the consumer comes down to at this stage. As company margins get squeezed by rising interest rates, tariffs, commodities prices, and other input costs, and as revenues disappoint because of a weakening or apprehensive consumer … let’s hope that this, at least, lasts.

 

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Fn

1.    Many in the financial industry suggest that, in both the U.S. and China, it has been rising interest rates, financial regulations and crackdowns (in China), and withdrawals of liquidity, that have been the primary culprits for the recent slowdowns in economic and stock market growth, with tariffs being only a small part of each nation’s respective recent problems. While rising borrowing costs clearly affect companies’ earnings and cause multiple-contraction in equities, expectations on the other side of the scale, of revenues and earnings, must decline significantly in order to see the kind of volatility and declines we have been seeing of late on the indices of both nations. As time goes by, it’s becoming increasingly clear that tariffs (on top of rising interest rates and stagnant wages) are going to cause growing economic and financial stresses for businesses and consumers, and investors are responding to these realities.

2.    There are many ways for businesses to handle rising costs, including: Finding new places to source products; re-examining and making changes to product mixes; commodities price hedging; renegotiating vendor and/or customer contracts; limiting discretionary spending; renegotiating or cancelling leases, etc.- but, all of these options can take significant time, have significant costs, and have unknown results and ramifications. Layoffs are a more immediate and predictable cost-cutting measure, and can be, relatively, easily reversed if necessary to resume growth or to repair miscalculations. Moreover, cutting labor overhead may give an employer the exact result it needs- as opposed to other cost-cutting measures.

3.    Oil prices have been heading lower, lately.

4.    Consumer spending, while up 2.3% over last year, has been up and down in recent months. Even in the “up” months, healthcare and energy prices- necessities- as opposed to luxuries and discretionary spending- have been responsible for the higher numbers. Hurricanes have also been the cause of much of the spending, such as on replacement vehicles that were damaged in storms.

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endnotes

1.    Remember that the monthly employment rate includes government jobs. Just as I’ve written about how the GDP includes government spending, the employment rate includes government jobs that result from government spending. So, again, the GDP can grow and the unemployment rate can decline, but there are ramifications for the national debt and the budget deficit for these positive economic results when government spending helps to feed GDP and labor force expansions. We pay for this growth.

2.    Millennials will be in for a big surprise when their idealistic views about job and career selection, demands and expectations from employers, and idealism about work environments no longer are addressed by employers, as job options diminish. Millennials’ expectations of work, such as their dreamy ideas of things like the so-called “gig economy” and quitting jobs and dropping-out of the workforce to chase passions, will be realigned in a slowdown or a recession with the reality of how difficult it is to make money, and support a family, and buy a home, and take vacations, and plan for retirement- things with which responsible adults have to deal.

3.    As economic growth slows, and unemployment rises, I’d pay attention to any “modern economy” type of industries. Crowdfunding will be decimated, as the amateur “investors” who “tinker” in highly speculative investments through these services, reign-in their excess or discretionary spending. Contrarily, the cannabis industry will likely see explosive growth, either despite, or perhaps because of a slowdown, as people seek an escape, become cynical about our economic and political systems and their own opportunities, and as states seek to grow their tax revenues.

4.    One might want to consider the implications of significant defaults on student loans should unemployment rise.

5.    In my two most recent articles, I advised- or warned- that the economy and your stocks would decline long before Wall Street says. Just look at the major stock indices, and reported revenues, and earnings guidance since the publications of those articles. Even the 10-yr. Treasury yield is off its highs.

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Neil Siskind is: President of The Siskind Law Firm, focused on product investments, trademark licensing, product distribution, and real estate; Founder & Chairman of The Fatherhood Assignment™, a think tank and advocate for children with absentee fathers; Founder of the global charity marketing initiative, Caring is Free®; Founder of National Fatherhood Day™; Owner & Conservator of The Neil S. Siskind Nature Preserve, over 8 acres of conserved waterfront land along New York’s majestic Hudson River; and author of The Complete Guide To The Ways To Manufacture & Sell Your Products. On December 11, 2017, in his article The Yield Curve Speaketh: Why Stocks Might Crash in Early 2018, Neil Siskind accurately predicted the February, 2018 stock crash, the largest single-day point drop in the Dow Jones Industrial Average’s history. In his September 26, 2018 article, Lots of “Bull” In The Bull Market: Let’s Look At What’s “Really” Growing, Neil Siskind explained how, despite Wall Street’s bullishness, the economic data and stock market underpinnings were in decline, and that the economy and stocks were at imminent risk. By the closing of markets on October 23, 2018, the S&P 500 had fallen approximately 7%, with October being the S&P’s worst month since August 2015, the Nasdaq continues to have its worst month since 2016, and is down approximately 8% from article publication, and the DJIA is having its worst monthly performance since 2008. If you are in need of office space in South Florida, contact Neil Siskind about space availability at The Siskind Executive Office Complex in Boca Raton, FL.

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