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Average Hourly Earnings Rose in May

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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. They have 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 the slope closely.

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Wage growth

Average hourly earnings rose $0.05 month-over-month in May 2016 and rose 2.5% year-over-year to $25.59. Average weekly hours were flat at 34.4 hours. While the increase in wages is potentially inflationary, we are nowhere close to the wage-push inflation we saw in the 1970s. Given the terrible growth in payrolls, we might see more flattening of wage inflation back towards the current inflation rate.

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 started to change in the late 1990s as wages grew at the inflation rate and real estate prices started 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 approaching bubble-type highs again. As the Fed removes accommodations, more home price appreciation will depend on wage growth.

Home price appreciation rates 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 D.R. Horton (DHI) move into entry-level brands. This is more about pushing through volume than increasing prices, which is a recipe for decreasing margins and higher volume. Toll Brothers (TOL) is focusing on 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 impact of the rise in employment costs at the end the first quarter.

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