Last week, the S&P 500 closed solidly above he 2000 level for the first time in history. Last week also marked the 2,006th day of rising prices if we date all the way back to the final bear market lows on March 9th of 2009. Investors have long forgotten what stock market pain feels like but strangely, as a group, they haven’t yet poured cash into equities as we might expect.
New Generation of Workers
I couldn’t possibly know what goes on in the minds of all people, what makes them act, think or choices they make in spending patterns. However, I do have a theory about what’s going on that seems to make sense in relation to what I’m seeing and what we know from studying the history of generations and economy. Here it goes. When I back out and look at the big picture of the US economy we know several things. We know that one of the biggest generations of all time (Baby Boomers) is now retiring at an accelerating rate. We are seeing this show up in Labor Force Participation rate charts, which continue to make new lows, almost record lows, as a percent of current population. This is the picture directly from the Bureau of Labor Statistics site
Meanwhile, we have an unemployment rate stated at 6.9%. So of course the difference between the chart above showing less than 63% of our AVAILABLE labor force is working, and the very low Unemployment rate, is captured in retirees. Retirees are eligible to work as part of the labor force but are not voluntarily doing so and thus they don’t count among the unemployed. Now, follow this through. When a large piece of the US population is not working voluntarily, we would expect several things. One, we will see a more modest growth rate in the economy. CHECK! 2.5% GDP, steady as she goes although unimpressively so. A smaller growth rate in the economy yields a labor environment where hourly earnings are also somewhat stagnant. In other words, those who are working are happy for the job and willing to work for reasonable, even lower, compensation. CHECK! Hourly earnings are stagnant over the last 5 years again despite the very low unemployment rate. Stick with me now. When hourly earnings are flat, there is no wage inflation to be seen. If you’ve ever taken an economics course, you know that the cost of capital (K) and the cost of labor (L), are the key ingredients to inflation. CHECK! There is no inflation and the Fed is in no hurry to raise interest rates. It all make’s sense if you look through the lens of generations.
Now let’s take this knowledge and use it. According to the work of most demographers, guys like Harry Dent and others, we shouldn’t expect the Baby Boomers to get out of the way (no offense) until the year 2024. At that point, we should see a real lack of supply in labor and begin to see some wage inflation as employers have to bid up compensation to attract employees. Until then, we still have a lot of baby boomers willing to stay in their jobs and retire gradually over time. Here’s the point. Investors should understand that earnings for corporations should remain very healthy as one of their highest costs of doing business, namely labor, remains low or stagnant. Better yet, our economy is much more service based than it used to be leading to higher demand for service-based businesses where labor is cheap. Investors should also be very careful about their assumptions regarding inflation. Some (many) are still married to the idea that gold and oil must rise and bonds must fall as the inevitable wave of inflation hits the economy. That might be the case, but you might also be off by a decade or so. The Fed is ending their QE measures, we know this but we shouldn’t make the assumption that inflation will suddenly and immediately shake the ground beneath us. I have personally gone completely around the horn on this issue. I still think inflation will be a large issue for our county but not for quite some time and more closely a bi-product of labor conditions. With that said, I still find Treasury bonds unattractive as an asset class. They simply do not offer an investor any reasonable income leaving you with a pile of price risk. If we need to be tolerant of price risk to be invested, we should own stocks, especially those paying juicy dividends.
I’ll finish with an attempt to answer the puzzle of money flow. Why is there still so much money sitting on the sidelines after 2006 days of rising stock prices? Why has some of this money NOT found its way into the stock market? Honestly, I think it comes back to the generational issues. The retiring baby boomer is not in a mood to add risk to their lives just ahead of retirement. The next generation is gun shy and thinks it’s too late to invest even as they are accumulating more and more money in bank accounts earning nothing. Finally, I think there is an embedded sense of doubt regarding what might happen with the Federal Reserve slowly ending their monetary support of the economy. The consensus view on the street is that when the Fed is gone, the market will go to hell. That will simply not happen and I’ll tell you why at the upcoming annual meeting on October 9th at the Denver Country Club. If you haven’t RSVP’d yet, space is limited! With that mind, we have to assume that stock prices are going to continue higher until we see some form of bullish capitulation with regards to all that cash or it will gradually deploy on every market pullback just like we saw in March and again in July of this year. The puzzle will be solved over time.
That’s it for this week; get outside for the best three weeks of the year!