Should an environment of slower economic growth and modest gains in productivity continue in the U.S., what are the investment implications? First, corporate earnings growth is closely linked to real GDP, making performance of domestic companies more vulnerable. Second, because wages typically rise in-line with productivity over the long term, they probably will not pick up as much as the rebound in the labor market would imply without a faster acceleration in productivity (we are already experiencing this phenomenon). Lackluster wage growth means consumer spending, and ultimately earnings for consumer-oriented companies, will also grow at a slower pace. A slower pace of growth should not be construed as a disaster, but it is troubling for the long-term returns of a stock market that is already pricing in the best of all possible worlds.
Market Realist – Anemic wage growth affects consumption.
The graph above shows the correlation between the economy’s real GDP and general wages and the correlation between the real GDP and S&P 500’s (SPY)(IVV) earnings, which are at 0.99 and 0.94, respectively. A correlation of 1 means that the two variables move in lockstep with each other. This means that both wages and corporate earnings move along with real GDP. Corporate earnings are the most important driver for stocks. Since wages move in the same direction, it’s no wonder that stock markets move in the direction of wages.
The bottom line is that the current trends in productivity could mean a long-lasting drag on the economy—if they persist. The problem is that there are very few available measures that could increase labor productivity.
Read our series 4 Factors Weighing On Labor Markets—And Implications For Fed Policy for more analysis of the current trends in the labor market.