It’s been a while since unemployment hasn’t increased in Spain
Unemployment is an important factor to consider when analyzing where an economy is in the business cycle. Spain, like other southern European countries, has been suffering from massive unemployment for the last four years. But in the second quarter, the unemployment rate dropped for the first time in nine quarters, falling from 27.2% to 26.3% on expectations of no change.
In the last post in this series, I said stocks are priced on future earnings expectations. Decelerating negative growth combined with falling unemployment is enough to make investors anticipate a brighter future ahead. But what’s driving the lower unemployment? Nominal wage growth was down -2.7% in the second quarter. Because Spain is on the euro, the country has no control over its monetary policy. This means that, unlike Iceland, the country can’t devalue in order to become more competitive and raise prices in its economy.
No help from monetary policy means wages need to fall
Instead, Spain is forced into an “internal devaluation.” Nominal wages tend to be “sticky.” This means that unlike asset prices, they don’t adjust quickly to changes in the economy. Nominal wages have only shrunk in four quarters over the last ten years, even as Spain’s economy fell to generational lows and unemployment soared. However, two of those four quarters were Q2 2013 and Q4 2012. If nominal wages fall further, they could increase employment and output going forward.
It may seem counterintuitive that falling nominal wages could be positive for an economy. But in the case of Spain, where the country can’t create inflation the way that the Federal Reserve in the US or the Bank of Japan can, there is little else that can boost employment when growth remains negative. Spanish stocks have been pricing in the potential for increased output over the second half of 2013, and further gains on the employment front would be bullish.