Wages Recovery Critical For Economic Growth

Before talking about wages and wages recovery in the United States, I would like to bring readers attention to a few remarks by Yellen on lack of savings. According to Yellen -

Large shares of American households have very few assets to fall back on and thus are extraordinarily vulnerable. Yellen noted that the bottom fifth of US households by income reported median net wealth of just $6,400. Meanwhile, families in the next fifth of the income distribution reported a net worth of $27,000. For both groups, the latest figures mark a decline from 2010, which Yellen attributed in part to continued declines in income.

A larger lesson from the financial crisis, of course, is how important it is to promote asset-building, including saving for a rainy day. Indeed, savings and other assets help cushion families from swings in the economy and unexpected events, such as an illness or job loss.

It is surprising that the Fed chair is talking about saving when it is promoting consumption and leverage through artificially low interest rates. I am completely in agreement with Yellen when she says that families should save for a rainy day, but I am not sure on the scope of saving for a middle-class US family amidst lower wages and rising cost of essentials such as food, energy, healthcare and education.

As the chart below shows, the household net worth has climbed since the crisis and this has primarily been due to an increase in housing prices and a rise in equity markets. However, the biggest beneficiaries of this gain have not been the middle and lower class income Americans who are still struggling with high leverage and low wages.

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The point I am trying to make is that wages are still not robust and until that happens, rise in housing and equity prices is not significant for an average American. Yes, it does immensely benefit the top 5% of the population in terms of annual income.

Coming to the point on wages, the chart below gives the average hourly earnings and the number of people unemployed per job opening.

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From 2008 to mid-2009 (the period of economic slump), the number of people unemployed per job opening surged along with a decline in wages growth. During the period of recovery (mid-2009 to mid-2013), the number of people unemployed per job openings declined along with a decline in wages growth year-on-year.

Currently, the wages growth year-on-year is less than 2% and this is the most important point in this entire discussion. I can say with conviction that the average annual inflation for a middle-class American is no less than 3%-5% on the conservative side. This means that the wages growth is negative when adjusted for inflation and this is a largely undesirable scenario.

With real wages on a decline, it is difficult to increase savings while keeping consumption at the same levels. I mentioned Yellen at the onset because the Feds policies are partly responsible for decline in real wages.

Easy monetary policies have resulted in asset inflation and it is not just equities and housing prices. Asset inflation has also impacted energy and agricultural commodities. The impact has been broad based as the Fed has no control over where the easy money flows. Therefore, the Fed is indirectly responsible for inflation, which has resulted in negative real wages growth.

I believe that setting a minimum wage policy for the corporate sector is not a solution to this problem. The solution is more related to favourable policies for the manufacturing sector (including tax holidays) and focus on the aging infrastructure sector. However, government policies seem to be favoring continued GDP growth from consumption.

I must add here that the US household has done exceedingly well in these difficult circumstances to boost the savings rate. Currently, the personal savings rate is at 5.4% as compared to a savings rate of 3.0% in December 2007. The households have acted rationally and conservatively in the crisis. However, it is time that the government and policymakers also act more rationally and conservatively.

If all this is considered from an investment perspective, my opinion is that consumption driven stories will witness moderate growth. Due to the seasonality impact, I am bullish on Wal-Mart (NYSE:WMT) for the next six months. However, the companys long-term growth will remain moderate until the company has a large presence in emerging markets.

Also, I believe that even if rise in interest rates come, it will be in baby steps and easy money will continue to flow in order to support the economy and asset markets. Investors can consider exposure to the Samp;P 500 (NYSEARCA:SPY) on current correction and I expect the markets to correct by 10% to 15% over the next 3-6 months.

I also believe that healthcare expenses will continue to remain high as they have been after the crisis. The healthcare sector spending has significantly contributed to GDP growth. This is not a desirable trend, but is likely to continue on demographic factors. Therefore, the Vanguard Health Care ETF (NYSEARCA:VHT) is a good investment option.

In conclusion, low wages growth will continue to impact the countrys consumption pattern and a large number of people not in the labour force will also result in increased savings rate. This trend is likely to have an impact on consumption driven stories. The key factor is how corporate America can offset this through growth from emerging market economies.