Investors were shocked by the “meager” 266,000 increase in payroll employment despite very widespread evidence that the economy is roaring back. It seems very clear that many workers prefer to take generous unemployment benefits rather than return to work, even as firms struggle to hire the labor they need to operate, even when they offer higher wages. Wages rose sharply across the job spectrum. In time, these higher labor costs will find their way into prices, increasing inflation. At least until the end of September, when the extra unemployment insurance benefits expire, hiring may continue to be restrained, even as labor costs rise more sharply. Yet, growth will likely remain robust. The implications are positive for stocks, but negative for bonds and we are managing accordingly.
Under normal circumstances, a 266,000 job gain in a single month would have been taken as evidence of a strong economy. It is disappointing only relative to the number of jobs still unemployed from before the pandemic. The extraordinary lopsided nature of the jobs gain is highlighted by the 331,000 increase in headcount for leisure and hospitality industries, accounting for 124.4% of the total job gain, or excluding leisure and hospitality, the rest of the economy suffered a net job loss of 65,000 workers. Clearly, this is inconsistent with everything else we know about the economic rebound.
The behavior of wage rates is equally anomalous. The average wage rate rose 0.7%, a very large increase that significantly understates the upward pressure on wage inflation. Several sectors reported wage gains in excess of 1.0% in a single month. But the average was pushed down by leisure and hospitality, where workers were paid 1.65% more in a single month, yet on average, workers are paid about half the national wage average. So, they brought the average down, even as they were paid considerably more. Firms found they needed to pay these workers more to get them to return to work. This is a consequence of the generous unemployment insurance that incentivizes workers to remain home, but also that many parents need to stay home until their kids go back to school. But what are the economic consequences of this?
The economic expansion is not in jeopardy. Growth will remain robust as the vaccine rollout enables people to get out and do more. But that economic rebound will add to the shortage of workers as firms try to respond to rising demand. Many firms will find it worthwhile to offer more pay to get the labor they need. The high measured 6.1% unemployment rate notwithstanding, labor costs are likely to remain under upward pressure, at least until those extra unemployment insurance benefits run out at the beginning of September. And most likely, that rise in labor costs will be reflected in higher inflation.
With economic growth prospects remaining so positive, and corporate earnings coming in even stronger than projected, stocks should perform quite well. Cyclical stocks should continue to perform well, especially financial companies, energy, and real estate in response to higher interest rates and somewhat more inflation. We have significant exposure to these industries. Even so, the rise in inflationary pressures reinforces the view that interest rates remain inconsistently low. So, we will continue to keep our duration short to protect against rising interest rates.