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Wages Are Increasing 2.3% per Year: What Does That Mean?

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Employment and wages are key indicators for the Fed 

Aside from employment, the most important indicator of economic well-being is wages. Despite falling unemployment, one of the conundrums facing the current labor market is flat real or inflation-adjusted wages. Over the past decade, wages have more or less kept pace with inflation, but they haven’t increased.

Before the financial crisis, much of the rise in consumption was due to asset price inflation, not wage inflation. Instead of getting big raises, people took out home equity lines of credit to fund consumption. This approach worked as long as housing prices kept rising.

However, since the bubble burst, wages have had to fund consumption, and they’ve been more or less flat. In the above chart, you can see how the line changed with the Great Recession in early 2009. Investors are watching closely for the slope to increase.

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Is wage growth finally breaking out?

Average hourly earnings rose $0.07 month-over-month in March 2016 and rose 2.3% year-over-year to $25.43. Average weekly hours fell 0.1 hours to 34.4. Given the rough patch in the global economy, the Fed might have an excuse not to hike rates in June. If wage inflation is returning, their hands will be tied.

On another practical level, once inflation starts again, you’ll also see a rise in long-term rates, which you can trade through the iShares 20-year Treasury Bond ETF (TLT).

Implications for homebuilders

Historically, real estate prices have correlated closely with wage growth. That relationship began to change in the late 1990s as wages grew at the inflation rate and real estate prices began posting double-digit gains. Recently, home prices have been rising again, but that’s due to low inventory.

If you use the median home price data from the National Association of Realtors, you’ll find that the ratio of median home price to median income is again approaching bubble-type highs. As the Fed removes accommodation, further home price appreciation will depend on wage growth.

Home price appreciation rates have deteriorated

Virtually all homebuilders’ average sales price growth rates have deteriorated. They’ve been content to keep a lean inventory and raise prices. That strategy seems to have been pushed as far as it can go.

Now we’re starting to see builders such as PulteGroup (PHM) and DR Horton (DHI) move into entry-level brands, which is more about pushing through volume than increasing prices. This is a recipe for decreasing margins and higher volume. Toll Brothers (TOL) is focusing on the high-end urban areas that have the strongest pricing.

Builders such as Lennar (LEN) have been reporting an increasing backlog, which bodes well for supply going forward. Investors interested in trading in the homebuilding sector might look at the SPDR S&P Homebuilders ETF (XHB) or the iShares US Home Construction ETF (ITB).

Now let’s look at the effect of the rise in employment costs at the end of 2015.

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