Hints of short-term stagflation
That was an interesting jobs Friday report. The payroll numbers missed expectations by 734,000 jobs1 and the things that barely moved by end of day were those you’d normally expect would decline: interest rates, inflation expectations and banking stocks. To be fair, all three were tanking until 10 am, but then the smart(er) money stepped in. It pored over the report, thought about it and decided that bonds weren’t worth buying after all. And so, rates backed up and we were back to even by end of day. So what was the smarter money thinking? Here are some clues.
Exhibit A is the construction sector where the report doesn’t immediately square with what we already know. Housing is booming with home prices up about 10% in the last one year. There is an epic shortage of lumber, with prices up 165% this year alone! So, construction wages grew as you’d expect, but the increase was abnormally high: 12% in April (annualized), highest since 2014. But the kicker is that despite these attractive wage increases, the number of jobs added in April was exactly zero! Zilch.
Why would such a hot sector add zero jobs? Answer: shortage of inputs leading to inability to produce homes whilst still paying higher prices. In other words, stagflation. Construction could be a microcosm of widespread material and labor supply problems in the US.
Once the pandemic got going last year, economic expectations were generally pessimistic. Thus, many upstream firms mothballed their raw material production capacity. Then the turnaround happened and its speed has been too fast for supply to catch up with demand. So you have material shortages all over the place: lumber, computer chips, grains, beef. It begs the question, why would you hire construction workers if you don’t have lumber to make new houses? Then, if you could somehow get the lumber or raw materials, will you be able to find the workers? That could be hard too.
What we have is a shortage of willing workers at the same time as raw material shortages. As per NFIB’s April report, small businesses are finding it harder to fill job openings than at any other time in 50 years!
(Also see NFIB’s Dunkelberg here.)
The factors holding back workers right now could take a few months to fix. One issue is that school closures or remote learning are still widespread making it difficult for both parents to work. As per the latest pulse survey more than 40% of K-12 kids are still learning from home. There is a clear macro effect: the labor participation rate for women aged 25-54 years ticked down by -0.1% in April while for men it ticked up by 0.2%.
The lingering pandemic is another elephant in the room. On the one hand covid lingers because vaccine hesitancy has snarled the US vaccination effort as predicted here and here. But because it lingers, many people remain afraid to expose themselves or their families. It also doesn’t help that unemployed people are more likely to be vaccine hesitant. Researchers at Yale found that only 57% of unemployed workers are open to covid vaccines vs 68% of the employed.
Lastly there is the issue of unemployment benefits and Biden’s covid relief package. This is a bit of a political hot potato with Democrats saying it is a non-issue (no surprise) and Republicans dead set against it (also not a surprise). The reality of this is however more nuanced than the political hot air. Here are two opposing data points to illustrate the point: the Leisure & Hospitality sector did very well in April with 331,000 jobs added despite being the lowest paying sector in the jobs report. But, the next lowest paying sector (Retail) performed poorly and lost 15,000 jobs!
So is covid relief discouraging people from working or is it not? That may depend on the labor market slack and the prevailing wage level. The pandemic caused Leisure & Hospitality to lose many more jobs than Retail: it is still 2.9 million jobs below pre-covid levels while Retail is down by just 0.4 million. So there may be enough slack in L&H to add more workers despite any drag from benefits. In Retail though, it is plausible that the extra benefits are making it harder to find workers. What about other sectors? Well, they are much better paying with hourly earnings of $25 and above. It seems implausible that they would be overly impacted by the $300 per week covid jobless benefit.
All said and done, these supply issues are not resolvable in a few days or weeks. One should therefore expect continued upward pressures on prices and wages. Meanwhile growth may well undershoot expectations this summer because you can’t consume more than the available supply. This is not going to be 1970s type super-stagflation, far from it, but perhaps the biggest stagflationary pressure we have seen in a long time.
How should one trade this scenario? Some of the best opportunities appear to be in supply squeezes. That’s a whole other topic but given that producers will be working to supply more, investors may want to evaluate the durability of supply problems to see if the squeeze has legs. Some materials are quicker to increase production, others take time. Some sectors (like construction, again!) have skills shortages that predate covid-19 in addition to the labor supply issues above. Ideally, any bullish bets on the squeeze should be protected by several “moats” that bears dare not cross.
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In comparison to a survey of economist expectations