Friday, April 9, 2021

The Myth of Stagnating Real Wages

In the past, I often have observed that, contrary to popular belief, inflation-adjusted wages have been expanding rather than stagnating for many years. Wage stagnation has been a popular myth perpetuated by progressives bemoaning workers’ plight to promote their own political agenda.

Naturally, progressives want even more progressive income taxes on higher-income workers and more social benefits for lower-income ones. Their goal is to redistribute income to reduce income inequality. They’ve actually succeeded in doing so, but they never seem to be satisfied. They always want more taxes and more benefits. The result is more “big government.” For now, let’s update the data that belie their basic claims:

(1) The wrong measure of inflation-adjusted wages. One measure of real wages seems to confirm the progressives’ stagnation thesis. Inflation-adjusted wages—defined as AHE divided by the CPI—peaked at a then-record high of $23.49 per hour during January 1973 (Fig. 1). It remained below that level until April 2020. That’s over 47 years! As of February 2021, it was only 1.4% above the 1973 peak. That’s pathetic.

I mean that analysis is pathetic. The CPI is widely known to be biased to the upside. A far better measure of consumer prices is the PCED. When we use that series to deflate the AHE series, we find that inflation-adjusted wages did stagnate during most of the 1970s through the mid-1990s. But it started moving higher around 1995 and has been achieving new highs since January 1999, rising along a trend line of 1.2% per year (Fig. 2).

(2) Rising standard of living. That represents a very solid increase in the purchasing power of consumers and in their standards of living! The real wage has increased 38% over the past 26 years from $16.18 during February 1995 to $22.34 during February 2021. Keep in mind that I am using AHE for production and nonsupervisory workers, who account for roughly 80% of private payrolls. This series certainly isn’t upwardly biased by the earnings of higher-wage workers.

Data available since 2006 show that AHE for higher-wage workers, on an inflation-adjusted basis using the PCED, rose 12.0% from the start of that year through February of this year (Fig. 3). Over the same period, AHE rose 19.5% for lower-wage workers.

Any way we slice or dice the data, the conclusion is the same: The income stagnation story is a myth. Standards of living have been rising for most Americans most of the time.

Monday, March 29, 2021

High-Octane Earnings

I am raising my S&P 500 operating earnings forecast for 2021 from $175 per share to $180, a 27.8% y/y increase from 2020. I am also raising my 2022 forecast from $190 to $200, an 11% increase over my new earnings target for this year. I would have raised my 2022 estimate more but for my expectation that the Biden administration will raise the corporate tax rate next year.

As I've observed, the economy was hot before the third round of “relief” checks started going out around mid-March. Now it is likely to turn red hot as the Treasury sends $1,400 checks or deposits to 285 million Americans in coming weeks.

I have also observed that the average of the business activity indexes compiled by the Federal Reserve Banks (FRBs) of New York and Philadelphia for their districts jumped from 17.6 during February to 34.6 during March, the highest reading since July 2004 (Fig. 1). This is a very significant development for the following reasons:

(1) Regional and national business surveys. Their average tends to be a good leading indicator for the average of the five surveys conducted by these two FRBs along with the ones in Richmond, Kansas City, and Dallas. The average of the five business activities indexes is highly correlated with the national M-PMI (Fig. 2). That means that the average of the New York and Philly indexes also is highly correlated with the national M-PMI and is signaling a solid number for the latter’s March reading (Fig. 3).

(2) Business indexes and S&P 500 revenues growth. “What does this have to do with S&P 500 earnings?,” you might be wondering. Good question. I won’t keep you in suspense. Previously, I’ve observed that the M-PMI is highly correlated with the y/y growth rate in S&P 500 aggregate revenues (Fig. 4). February’s M-PMI reading of 60.8 matches some of the best readings in this indicator since 2004! The March reading could be stronger, implying that S&P 500 revenues may be set to grow 10%-15% this year. That’s certainly confirmed by the similar relationship between the growth in revenues and the average of the New York and Philly business activity indexes (Fig. 5).

(3) Profit margin. That strong outlook for revenues growth provides a very good tailwind for earnings growth, which will also get a lift from a rising profit margin. I think that the profit margin, which averaged 10.4% last year, could increase both this year and next year. Profit margins tend to rebound after recessions and during recoveries along with productivity.

(4) Bottom line on the bottom line. Let’s put it all together now. I am raising my S&P 500 revenues forecast by $50 to $1,550 per share this year, up 14.0% from the 2020 level (Fig. 6). For next year, I am sticking with my $1,600 revenues estimate, representing just a 3.2% increase. That’s because I believe that the relief checks, besides relieving pent-up demand, will pull forward some of next year’s demand. Also, individual tax rates are likely to go up next year along with corporate ones.

I am projecting that the S&P 500 profit margin will increase from 10.4% last year to 11.6% this year and 12.5% next year (Fig. 7). The result would be S&P 500 earnings of $180 per share this year and $200 next year (Fig. 8). (See YRI S&P 500 Earnings Forecast.)

Analysts Bullish on S&P 500 Fundamentals

I am not the only one turning even more bullish on the fundamentals driving the stock market. Industry analysts also are raising their estimates for revenues, earnings, and profit margins for the S&P 500 for this year and next year. Consider the following:

(1) Quarterly consensus earnings estimates for 2021. The analysts’ consensus estimates for quarterly S&P 500 earnings per share this year have been rising since mid-2020 (Fig. 9). As of the March 18 week, they were projecting the following y/y growth rates for S&P 500 operating earnings: Q1 (20.0%), Q2, (50.1), Q3 (18.0), and Q4 (12.5) (Fig. 10).

(2) Annual consensus earnings estimates for 2021 and 2022. As of the March 18 week, the consensus predicted that S&P 500 earnings per share will be $175.54 this year and $202.11 next year (Fig. 11). Currently, industry analysts are expecting that S&P 500 earnings will increase 25.5% this year compared to last year (Fig. 12). For 2022, they are anticipating a 15.2% growth rate.

(3) Annual consensus revenues and margin estimates for 2021 and 2022. Industry analysts are currently projecting that revenues will total $1,459.08 this year and $1,558.19 next year (Fig. 13). In other words, they are expecting revenues per share to grow 9.4% in 2021 and 6.8% during 2022 (Fig. 14).

Interestingly, their estimate for 2021 revenues growth has been increasing since the week of November 19, undoubtedly reflecting expectations that President Biden’s American Rescue Plan would be enacted early this year and be very stimulative, adding roughly two percentage points to revenues growth. The expected growth rate for 2022 hasn’t changed much since late last year.

I calculate the implied profit margins from the consensus estimates for earnings and revenues. The results show that margin estimates have been improving since last summer for 2020, 2021, and 2022. The latest readings for these in 2021 and 2022 are 11.8% and 12.7% (Fig. 15).

(4) Forward ho! Both S&P 500 forward revenues and forward earnings have now fully recovered what they lost during the first few months of the pandemic (Fig. 16). Both took much longer to recover during the Great Financial Crisis. The same can be said for the forward profit margin. The weekly forward revenues, earnings, and profit margin series are all excellent coincident indicators of the comparable actual comparable data (Fig. 17). All three of the weekly series remain bullish on the underlying fundamentals for the S&P 500.

I am raising my year-end 2021 and 2022 forward earnings forecasts by $5 each to $200 and $210 (Fig. 18). Think of these as my best guess of what industry analysts will be projecting earnings will be in 2022 and 2023 at the end of 2021 and 2022. (See our 2020 study titled S&P 500 Earnings, Valuation, & the Pandemic for a thorough explanation of forward earnings.)

(5) S&P 500 targets and valuation. Even though I am raising my forward earnings targets, I am keeping my S&P 500 stock price targets at 4300 and 4800 by the end of this year and next year. That buys me a bit more wiggle room on our valuation multiple assumptions, which are now 21.5 and 22.9 for the end of this year and next year (Fig. 19). The multiple is currently 21.6.

One of my accounts asked me whether I should lower my outlook for the forward P/E given that I am predicting that the 10-year US Treasury bond yield is likely to rise back to its pre-pandemic range of 2.00%-3.00% over the next 12-18 months.

Normally in the past, I would have lowered my estimates for forward P/Es in a rising-yield environment. However, these are not normal times. In the “New Abnormal,” valuation multiples are likely to remain elevated around current elevated levels because fiscal and monetary policies continue to flood the financial

Thursday, March 11, 2021

Rent: From Headwind To Tailwind

Rent is one of the major components of both the Consumer Price Index (CPI) and the personal consumption expenditures deflator (PCED). Rent inflation has been falling since the start of the pandemic. So it has helped to keep a lid on overall consumer price inflation. Rent disinflation has offset price increases resulting from the stimulative monetary and fiscal policies implemented by the government to shore up the financial system and to revive economic growth. So far, rent disinflation has provided a headwind for overall inflation.

However, a shortage of houses for sale combined with rapidly rising home prices and mortgage rates could soon boost rent inflation, providing a tailwind for overall inflation. Consider the following:

(1) Housing market. The pandemic triggered a wave of deurbanization. City dwellers, especially those renting apartments, suddenly decided it was time to buy a house in the suburbs. They wanted big yards with swimming pools for their kids, home offices, and more distance from their neighbors. At the same time, the Fed’s ultra-easy monetary policies caused mortgage rates to fall to record lows. That only stoked demand for houses.

During the lockdowns at the start of the pandemic, the sum of existing plus new single-family homes plunged from 5.83 million units (saar) in February 2020 to 4.35 million units in May (Fig. 1). As the lockdown restrictions were lifted, home sales soared to a high of 6.98 million units during October, the best reading since April 2006. They remained around that pace through January.

The problem is that the inventory of existing and new homes for sale fell to a record low of 1.19 million units during January (Fig. 2). Demand is seriously outstripping supply. So home prices are soaring. The median and average prices of existing single-family homes rose 14.8% y/y and 12.3% y/y through January to fresh record highs (Fig. 3). Median home prices are up at double-digit rates in the Northeast (18.4%), West (17.5), Midwest (15.1), and South (14.7) (Fig. 4).

The backup in bond yields has caused the 15-year fixed-rate mortgage yield to rise from a record low of 2.32% on January 4 to 2.54% on Friday (Fig. 5). It’s likely to keep rising along with bond yields. The combination of low inventories of homes, soaring home prices, and rising mortgage rates may already be weighing on mortgage applications to purchase homes (Fig. 6).

Building a new home has become more expensive as lumber prices have soared (Fig. 7). We’ve heard that many builders are so busy that they tell prospective new homebuyers that they won’t be able to start on their projects for 12-18 months.

(2) Rental market. In other words, the lack of availability and the declining affordability of homes could convince urban dwellers to stay put in their rental apartments. For now, some might be able to negotiate a better rental deal with their landlord. However, the rental market could tighten later this year if the availability and affordability of homes discourages would-be homebuyers.

The inflation rate of the CPI for tenant rent fell to 2.1% y/y during January, down from 3.8% a year ago (Fig. 8). Following the Great Financial Crisis (GFC) of 2008, tenant rent inflation plunged to a low of -0.1% during May 2010, down from 4.6% during March 2007.

During the GFC and for a few years following this calamity, there was a glut of distressed homes for sale. Home prices fell, and so did rents. The Great Virus Crisis boosted the demand for homes and their prices, sending rent inflation downward. But rent inflation may not have much lower to go and could be on the way up again later this year for the reasons discussed above.

(3) Rent in consumer prices. In the CPI, rent of shelter includes tenant rent and owners’ equivalent rent. The latter closely tracks the former. Rent of shelter accounts for 33.3% of the headline CPI, 41.8% of the core CPI, and 53.1% of CPI services. Rent of shelter accounts for 16.6% of the PCED, 18.8% of the core PCED, and 25.3% of PCED services.

(4) Phillips curve. Fed officials seem to be running monetary policy under the influence of the notion that the Phillips curve is dead. It wasn’t too long ago that they believed that inflation is inversely correlated with the unemployment rate. The only question in their minds was whether this relationship had flattened in recent years given that record-low unemployment prior to the pandemic wasn’t heating up inflation after all, as they previously had feared.

Now Fed officials believe that they should continue to overheat the economy with monetary policy to achieve maximum employment by next year; yet any pickup in inflation will be transient. I tend to agree with them. However, for the record, there still is an inverse relationship between the jobless rate and the inflation rate of rent of shelter in the CPI (Fig. 9). Furthermore, there is a direct relationship between wage inflation and rent inflation (Fig. 10).

During February, the unemployment rate remained high at 6.2%. However, average hourly earnings rose at a fast pace of 5.3% y/y during the month. We’ve previously suggested that generous government unemployment benefits are keeping people from seeking jobs, resulting in labor shortages. That would explain why wage inflation might remain high. If so, then that could soon cause rent inflation to stop falling and start moving higher. The headwind for overall inflation could turn into a tailwind!

Friday, March 5, 2021

Checks Without Balances


Washington’s lawmakers have discovered the joys of sending checks to their constituents during bad times. They’ve done it twice so far since the start of the pandemic and are likely to do it a third time shortly. The $1,200-per-person checks sent during April did work to revive the economy from last year’s two-month recession during March and April. The $600 checks sent during January certainly averted any stalling in economic growth in the face of the third wave of the pandemic. It’s not hard to guess what another round of $1,400 checks will do to the economy. Consider the following:

(1) Pandemic. On a 10-day moving average basis, Covid-19 hospitalizations have plunged 55% from a record high of 130,386 during January 15 to 58,394 during February 26 (Fig. 1). That’s the lowest pace since November 12, 2020. The Food and Drug Administration on February 27 authorized Johnson & Johnson’s single-shot Covid-19 vaccine for emergency use. J&J will provide the US with 100 million doses by the end of June. When combined with the 600 million doses from the two-shot vaccines made by Pfizer-BioNTech and Moderna slated to arrive by the end of July, there will be more than enough shots to cover any American adult who wants one this summer.

The new vaccine’s 72% efficacy rate in US clinical trials falls short of the roughly 95% rate found in studies testing the Moderna and Pfizer-BioNTech vaccines. Across all trial sites, the Johnson & Johnson vaccine also showed 85% efficacy against severe forms of Covid-19 and 100% efficacy against hospitalization and death. That sounds like a winner for sure! To repeat: 100% efficacy against hospitalization and death. That should turn the plague into a pest by the second half of this year.

In his February 23 congressional testimony on monetary policy, Fed Chair Jerome Powell said, “While we should not underestimate the challenges we currently face, developments point to an improved outlook for later this year. In particular, ongoing progress in vaccinations should help speed the return to normal activities.” I think that both monetary and fiscal policymakers underestimate the stimulative impact of the end of the pandemic.

(2) Real GDP. The V-shaped recovery in real GDP will remain V-shaped during the first half of this year and probably through the end of the year. However, it will no longer be a “recovery” beyond Q1 because real GDP will have fully recovered during the current quarter. Thereafter, GDP will be in an “expansion” in record-high territory.

Last year, real GDP rebounded 33.4% (saar) during Q3 and 4.1% during Q4 (Fig. 2). We are projecting 7.0% during Q1. On Monday, we raised our Q2 estimate from 4.5% to 9.0%, mostly because we expect that President Biden’s American Rescue Plan will be enacted in the next few weeks.

The plan will provide checks of $1,400 per eligible person, mostly during April, we reckon, providing another big boost to consumer incomes and spending. Last year, consumer spending in real GDP rose 41.0% during Q3 and 2.4% during Q4. The Atlanta Fed’s GDPNow model showed an 8.8% increase in such spending during Q1 as of March 1 (with real GDP up 10.0%). We forecast that real consumer spending will increase 7.9% during Q1 and 11.3% during Q2.

(3) Personal income. In current dollars, personal income jumped by a record 12.4% m/m during April 2020 as a result of a $3.3 trillion (saar) increase in government social benefits that month, thanks to the $1,200 checks and generous unemployment benefits (Fig. 3 and Fig. 4). January’s 10.0% increase in personal income was the second biggest ever in a month, as a result of a $2.0 trillion increase in benefits attributable to the $600 checks.

If the next round of $1,400 checks goes out in April, it will undoubtedly boost personal income by a new record amount to another record high! The “other” component of government social benefits in personal income includes an item for “Economic Impact Payments” (Fig. 5). At an annual rate, these checks from the Treasury boosted benefits and total personal income by $2.6 trillion and $0.6 trillion, respectively, during April and May of last year. They boosted them both by $1.7 trillion during January. So they accounted for virtually the entire $1.9 trillion increase in personal income during January!

(4) Personal consumption. The government checks certainly contributed to the V-shaped recovery in consumer spending (Fig. 6). Another round of checks will do the same this spring. In current dollars, consumer spending rose 2.4% m/m during January, led by a 5.8% m/m increase in consumption of goods to a new record high. In coming months, consumers should be able to spend much more on services that have been limited by the pandemic’s social-distancing protocols.

(5) Personal saving. During last year’s lockdowns, consumers couldn’t spend either their paychecks or government benefits as readily as usual since most stores and restaurants were closed. So personal saving soared to a record $6.4 trillion (saar) during April (Fig. 7). It then fell to $2.3 trillion by December, which was still well above the $1.3 trillion pace of personal saving at the start of last year.

Interestingly, January’s $2.0 trillion jump in government social benefits coincided with a $1.6 trillion increase in personal saving to $3.9 trillion, suggesting that much of the month’s stimulus hasn’t been spent yet. After the year-end holiday season, January is not a prime month for shopping.

So there is plenty of stimulus left over. In addition, consumer revolving credit outstanding dropped $118 billion y/y through December to $976 billion (Fig. 8). The ratio of consumer revolving credit to personal consumption (both in current dollars) dropped from 7.4% to 6.7% over this period (Fig. 9). This suggests that consumers aren’t as reliant on their credit cards because they have plenty of cash. Moreover, once they spend their extra cash, they can always tap into their credit cards again.

(6) Unemployment benefits. The Biden plan will extend temporary pandemic relief programs for unemployed workers, expiring on March 14, to August 26. Benefit recipients would also get an extra $400 a week. More than 19 million Americans were collecting benefits as of early February, according to the Labor Department. Last year, unemployment benefits in personal income totaled $550.2 billion, up from $27.7 billion during 2019.

Our February 9 Morning Briefing was titled “The Government Is Here To Help.” We reviewed the recent Washington Post op-ed by economist Larry Summers in which he trashed President Biden’s American Rescue Plan as too stimulative and too inflationary. He also strongly implied that the plan included overly generous unemployment benefits that would discourage the unemployed from taking jobs. In fact, there is mounting evidence that the pandemic-related unemployment benefits provided last year have been doing the same.

Our February 10 Morning Briefing was titled “Help Wanted.” We wrote, “There actually seem to be lots of job openings, but fewer people willing to take them. That would explain why wages have been rising at a faster pace in recent months.”

(7) Bottom line. There is plenty of stimulus left in the pipeline from last year’s pandemic rescue programs. More rounds of government stimulus programs this year are likely to cause a boom that overheats the post-pandemic economy, which might result in higher inflation. The government’s overly generous extended unemployment benefits could frustrate policymakers’ goal of achieving full employment while driving up wage inflation.

Too much of a good thing is often just too much. The economy is hot and will get hotter with the bonfire of the fiscal and monetary insanities.

Sunday, February 21, 2021

S&P 500 Earnings: V-Shaped Recovery

On the health front of the world war against the virus (WWV), the third wave of the pandemic, which started around Halloween, has been the worst by far (Fig. 1). However, it crested on January 15, when the 10-day moving average of hospitalizations peaked at 232,583. This series was down 56% to 101,407 on February 15. That’s encouraging. Hopefully, there won’t be another wave related to the Super Bowl. Meanwhile, the pace of vaccinations is picking up, which should change Covid-19 from a plague to a pest.

Notwithstanding the severity of the third wave of the pandemic during the fourth quarter of last year and early this year, a great deal of progress has been made on the economic front of WWV. The US continues to trace out a V-shaped recovery. The same can be said about the global economy. That’s showing up in the V-shaped recovery in S&P 500 earnings. So the V-shaped rebound in the S&P 500 stock price index has been justified by the rebound in earnings. The index hasn’t been disconnected from the economy as widely believed.

Of course, the remarkable progress made on the financial front of WWV in both the stock and credit markets has been largely driven by the unprecedented stimulus provided by fiscal and monetary policies around the world. Credit-quality yield spreads have narrowed, and corporate and municipal bond yields have dropped to pre-pandemic readings. The financial system and global economy are awash in liquidity, resulting in elevated valuation multiples.

Let’s review the V-shaped recovery in S&P 500 revenues, earnings, and profit margins:

(1) Q4 earnings season. Let’s start with the Q4 reporting season. So far, 369 of the S&P 500 companies have reported. During the week of February 11, S&P 500 earnings for the quarter came in at $42.26 per share using the blend of actual and estimated earnings (Fig. 2). That’s up 14.6% from the estimate during the week of December 31, just prior to the latest season. Remarkably, the latest blended earnings number for Q4 is up 0.6% y/y! That follows the following declines during the previous three quarters: Q1 (-15.4%), Q2 (-32.3), and Q3 (-8.2) (Fig. 3).

That certainly was a V-shaped recovery in the quarterly earnings-per-share numbers last year, although 2020’s total was down 14% to $140 per share from $163 in 2019. We are predicting $175 for this year, which would be a 25% rebound from last year’s total.

(2) Forward revenues and earnings. Also showing V-shaped recovery formations are S&P 500’s forward revenues and forward earnings, i.e., the time-weighted average of consensus estimates for this year and next year (Fig. 4). Both certainly stand out as V-shaped compared to their U-shaped recoveries during the Great Financial Crisis.[1]

Forward revenues per share is a great weekly coincident indicator of actual S&P 500 revenues per share (Fig. 5). During the week of February 4, the former was only 0.5% below its record high during the week of March 5.

Forward earnings per share is a great weekly year-ahead leading indicator of actual S&P 500 operating earnings on a four-quarter trailing basis (Fig. 6 and Fig. 7). Admittedly, it doesn’t see recessions coming, but it works very well during economic recoveries and expansions. It was $176.78 during the week of February 11, only 1.2% below its record high during the week of January 30, 2020. That latest number is about the same as our forecast for the year.

(3) Profit margin. Apparently, companies scrambled to cut their costs when the pandemic hit only to find that their sales recovered sooner than expected. That explains why the S&P 500 forward profit margin plunged from 12.0% at the start of 2020 to 10.3% during the week of May 28 and rebounded back to 11.9% during the week of February 4 (Fig. 8). Here are the latest analysts’ consensus profit margin estimates for 2020 (10.2%), 2021 (11.7%), and 2022 (12.7%) (Fig. 9).