Getting a read on the Goldilocks economy

Last week saw the release of the latest U.S. employment report, with just 148,000 nonfarm payrolls created in December.¹ This was significantly below expectations and the previous month’s reading. However, it may have been a Goldilocks jobs report: It is good enough to stave off any concerns that the economy may be weakening, but it’s not strong enough to suggest that the economy is overheating.

Why is this important? One of the biggest risks we have to be concerned about in 2018 is that central banks will remove monetary policy accommodation more quickly than expected because they are concerned the economy is growing too quickly. This jobs report will likely assuage concerns by the Federal Reserve – at least for right now. For example, the headline unemployment rate remained unchanged at 4.1%, while the U6 rate (the broadest reading of unemployment, which factors in discouraged and underemployed workers) actually moved up from 8% to 8.1%.¹ And while average hourly earnings rose 0.3% month over month, we also saw downward revisions to previous months so that the annual growth rate is a still-modest 2.5%.¹

Goldilocks scenarios are happening globally

We are seeing a similar situation playing out in the eurozone. The economy is accelerating at an impressive pace. Economists at the European Central Bank (ECB) are forecasting a final eurozone growth figure of 2.4% for 2017. This is a significant upward revision from their estimate just a year ago, when they forecasted growth of 1.7% for 2017.² At the same time, inflation has remained very tame. The euro area (EA19) flash estimate of inflation in December clocked in at 1.4% annualized, lower than the 1.5% annualized rate in November.³ This data undoubtedly helped drive Friday’s rally in European stocks. That’s because investors assume that even though growth is accelerating, inflation is low enough that there is little reason for the ECB to accelerate its current pace of quantitative easing tapering.

Japan is also experiencing a Goldilocks-like scenario. Economic growth has accelerated significantly and, while inflation has increased, it still remains relatively tame.

And so we find ourselves in a very attractive situation: a somewhat synchronized global growth environment with low inflation. However, this is, like all good things, only temporary. We will need to enjoy it while we can, keeping an eye out for changes to this picture in terms of growth, inflation or both. One possible source of higher growth are the tax cuts taking effect in several different countries, including the U.S. and France. And there is of course the potential for wage growth to rise substantially in 2018 in a variety of economies, which could fuel inflation.

Is wage growth on the horizon?

Let’s take the U.S. economy. What we saw in the December jobs report was a decrease in retail jobs, but an increase in manufacturing jobs. Interestingly, a few years ago we saw a very different trend – growth in retail jobs and a loss in manufacturing jobs – which I believe contributed to downward pressure on wage growth because manufacturing jobs typically pay more than retail jobs. If the growth in manufacturing jobs continues and becomes a more lasting trend, we are likely to have upward pressure on wage growth, in my view. More importantly, we are seeing increases in the minimum wage in a number of municipalities in the U.S., which should put significant upward pressure on wage growth. Fortune magazine reported in December that in 2018 there will be minimum wage increases for workers in 18 U.S. states and 20 American cities.

Wage growth could rise in other parts of the world as well as pressure points develop:

• IG Metall, Germany’s largest union, is demanding a 6% wage rise this year for its 3.9 million workers. Employers have counteroffered a 2% increase as well as a one-off payment in the first quarter, but the union is not satisfied and has planned a strike for this week⁴
• Next year, South Korea’s minimum wage will leap by 16.4% to 7,530 won ($6.65) an hour – the biggest wage hike since 2000. The target minimum wage by 2020 is 10,000 won, which constitutes an increase of 55% in total. This would elevate South Korea’s minimum wage to approximately 70% of its median wage – a much higher level than in other major economies⁵
• In December, Japan enacted new corporate tax cuts that are tied to incentives such as wage growth; specifically, corporate taxes will fall to 25% for those companies that raise wages by 3%⁶
• A number of provinces in Canada are also experiencing minimum wage increases. While most will be modest, Ontario’s minimum wage will rise more than 20% this year, which represents the largest minimum wage increase in more than 40 years, and Alberta’s minimum wage is planned to increase more than 10%⁷

Key takeaway

For now, investors can enjoy the Goldilocks environment of growth that is not too slow and not too fast, which I believe will likely be positive for equity investing. However, we can’t ignore the specter of higher inflation. This means considering the potential benefits of inflation-hedging investments, including commodities, real estate investment trusts (REITs), gold and inflation-linked bonds.

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