Stock market bulls should buy these low-labor cost companies: Goldman Sachs

With the unemployment rate at near fifty year lows, and job growth outpacing the growth of the labor force, it’s no surprise that U.S. companies are expressing concern about the effect of rising wages on their bottom lines.

Despite these worries, companies with low labor costs have been significantly underperforming the market, according to an analysis by Goldman Sachs, which argues that such stocks could be a good buy for those who think fears of a significant U.S. economic slowdown are overblown.

“If job and wage growth prove resilient, the relatively insulated stocks [with low labor costs] should outperform higher labor cost peers facing more rising more margin risk from rising input costs,” wrote Goldman analysts, led by equity strategist Ben Snider, in a Monday note to clients.

Goldman created a basket of the 50 companies with the S&P 500 index that have the lowest labor costs relative to their revenues, finding that it trades at a forward price-to-earnings ratio (P/E) of 13 times, versus a similar basket of 50 high labor-cost firms, which trade at a multiple of 22 times earnings. The median S&P 500 company sports a forward price-to-earnings ratio of 18 times.

While wage growth has slowed from a peak of 3.3% in the fourth quarter of 2018, the fastest since 2007, “leading indicators show that wage growth should remain at or slightly above its current pace of 3%,” Snider wrote.

That’s faster than projected economic growth of 2.5% and projected earnings growth of 2.6% in 2019, according to FactSet, and company management is concerned about the trend, according to surveys conducted by the National Federation of Independent Business and the National Association of Business Economics.

The Goldman basket of low labor-cost firms is sector neutral, and includes Dish Network Corp.

DISH, +0.92%

Altria Group Inc.

MO, +0.15%

Aflac Inc.

AFL, -0.02%

McKesson Corp.

MCK, +1.58%

Dow Jones Industrial Average

DJIA, +0.71%

  component Apple Inc.

AAPL, +0.42%

  and Sykworks Solutions Inc.

SWKS, -0.80%

all of which trade below the median S&P 500 company’s forward price-to-earnings ratio, and have labor costs of 6% or less of revenue.

Corporate profit margins rose to an all-time high level of more than 10% in 2018, but have fallen this year, with the consensus estimates showing a 0.6% decline this year, while projecting a 0.7% rise next year, which Goldman analysts think is too optimistic. “From a top-down perspective, our forecast of flat profit margins — due in part to rising labor costs — explains most of the difference between the 4% growth we expect in S&P 500 and the 12% growth currently embedded in consensus estimates.”

Another reason to expect continued wage pressure is the increasing incidence of rising minimum wages in states and localities across the U.S. “Although the federal minimum wage has been unchanged at $7.25 for a decade, rising state minimum wages continue to lift the effective national minimum,” Snider wrote. “The effective US national minimum wage grew by 4% in 2018 to $8.88, and current state laws indicate that it will rise by another 4% in 2019 to $9.18 even without any mandated increase at the federal level.”

To be sure, investing in these low labor-cost firms might not be advantageous if investors believe that a trend in lower bond yields, along with an inverted yield curve, signals a forthcoming recession, which would likely lead to rising unemployment and the easing of wage pressures.

Interestingly, there has been a strong correlation of late between the performance Goldman’s low-wage basket of stocks and the markets expectations for inflation.

The 10-year break-even inflation rate measures market expectations for inflation by taking the difference between the 10-year U.S. Treasure note and similar notes indexed for inflation. Looking at these data, it could be assumed that stock market investors are betting on a coming recession with the same conviction that bond market investors are, and were actually earlier to adopt that position.

But there are just as many reasons to remain bullish about the economy going forward, including a strong jobs market, high levels of consumer confidence, and indications that the Federal Reserve is willing to cut interest rates before hard evidence of a significant economic slowdown emerges. In that case, it could be that investors are just underestimating the advantages that firms with low labor costs will bring to the table.

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U.S. labor market tightening; inflation pressures moderate

U.S. labor market tightening; inflation pressures moderate

WASHINGTON (Reuters) – The number of Americans filing applications for unemployment benefits dropped to a 49-1/2-year low last week, pointing to sustained labor market strength that could assuage fears the economy was rapidly losing momentum.

FILE PHOTO: A worker assembles an industrial valve at Emerson Electric Co.’s factory in Marshalltown, Iowa, U.S., July 26, 2018. REUTERS/Timothy Aeppel/File Photo

Other data on Thursday showed producer prices increased by the most in five months in March amid a surge in the cost of gasoline. But underlying producer prices remained soft, the latest indication of tame inflation pressures that strengthen the Federal Reserve’s decision to suspend further interest rate increases this year despite a tight labor market.

“The economy’s wheels continue to turn and any thought that growth was going to stop has to be reassessed,” said Chris Rupkey, chief economist at MUFG in New York. “Fed officials are on the sidelines awaiting confirmation of what to do next.”

Initial claims for state unemployment benefits fell 8,000 to a seasonally adjusted 196,000 for the week ended April 6, the Labor Department said. That was the lowest level since October 1969, when the size of the labor market was about half of what it is now. Claims have declined for four straight weeks.

Economists polled by Reuters had forecast claims rising to 211,000 in the latest week. The four-week moving average of initial claims, considered a better measure of labor market trends as it irons out week-to-week volatility, fell 7,000 to 207,000 last week, the lowest level since December 1969.

The labor market’s strength should allay worries of an abrupt slowdown in economic growth, which gained traction after the U.S. Treasury yield curve briefly inverted in late March.

The economy lost speed at the turn of the year, reflecting fading stimulus from a $1.5 trillion tax cut package, trade tensions between China and the United States and weak global growth. Data, including retail sales and the trade deficit, have improved, raising the possibility that the anticipated slowdown in growth in the first quarter will not be steep.

Goldman Sachs is forecasting gross domestic product rising at a 1.6% annualized rate in the first quarter. The economy grew at a 2.2% pace in the October-December period.

Job growth in the first quarter averaged 180,000 per month, well above the roughly 100,000 needed to keep up with growth in the working-age population. At 3.8%, the unemployment rate is near the 3.7% Fed officials project it will be by the end of the year.

U.S. Treasury prices fell, while the dollar was little changed against a basket of currencies. Stocks on Wall Street were trading marginally higher.


In a second report on Thursday, the Labor Department said its producer price index for final demand rose 0.6% in March, the largest increase since last October, after edging up 0.1% in February.

In the 12 months through March, the PPI rose 2.2% after advancing 1.9% in the 12 months through February. Economists had forecast the PPI climbing 0.3% in March and increasing 1.9% on a year-on-year basis.

A key gauge of underlying producer price pressures that excludes food, energy and trade services was unchanged last month after ticking up 0.1% in February. The so-called core PPI increased 2.0% in the 12 months through March. That was the smallest annual increase since August 2017 and followed a 2.3% rise in February.

Data on Wednesday showed consumer prices rose by the most in 14 months in March, driven by more expensive gasoline. But core inflation remained muted amid a plunge in the cost of apparel.

“The recent consumer and producer price data don’t point to any major acceleration or deceleration in inflation,” said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania. “Therefore, the Fed will feel no economic pressure to do anything.”

Minutes of the Fed’s March 19-20 policy meeting published on Wednesday described inflation as “muted,” though officials expected it to rise to or near the U.S. central bank’s 2% target. The Fed’s preferred inflation measure, the core personal consumption expenditures (PCE) price index, is currently at 1.8%.

The minutes showed some Fed officials believed the tame price pressures could be the result of low inflation expectations and also an indication that there was still slack in the labor market despite the very low unemployment rate.

Last month, gasoline prices shot up 16.0%, the most since August 2009. Gasoline accounted for over 60% of the 1.% rise in goods prices last month. Goods prices increased 0.4% in February.

Prices for healthcare services fell 0.2% last month after rising 0.3% in February. The cost of hospital outpatient services fell by the most since July 2014. Those healthcare costs feed into the core PCE price index and suggested weaker inflation readings in February and March.

“We look for moderation (in the core PCE price index) to 1.70% in February and 1.60% in March,” said Daniel Silver, an economist at JPMorgan in New York.

The Commerce Department will publish February and March PCE price data later this month.

Reporting by Lucia Mutikani; Editing by Paul Simao and Dan Grebler

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No Statistic Will Help You Beat the Market

No Statistic Will Help You Beat the Market
Photo: Drew Angerer/Getty Images

There’s a statistic for everything, especially in investing. Writers and financial experts love to pick out minutiae from the markets and posit that they mean something BIG and EXPLOSIVE about the state of the economy—and now that you know it too, you have some sort of investing edge. (If you were paying attention to all of these posts, about a million different indicators flashed that a recession was “imminent” in the past few years, and, well.) If you want, you can get market information down to the second.

But there’s no stat that’s going to help you “beat” the market consistently. There are just too many variables, and no one actually knows what the market will do. As Michael Batnick notes in his post on the Irrelevant Investor, Jack Bogle wrote in his book Enough:

Numbers are not reality. At best, they are a pale reflection of reality. At worst, they’re a gross distortion of the truths we seek to measure.

There’s enough information out there that you could spend all of your time parsing stats to “optimize” your investments. “The reason certain people eat this up is because it provides the illusion that we live in a world where the future will resemble the past,” Batnick writes. But predicting the market, as with life, is impossible.

That’s not to say you shouldn’t familiarize yourself with its ebbs and flows (after all, that’s the information we’re using to recommend that people invest in low-cost mutual funds)—but you don’t need to bury yourself in superfluous statistics that have no real bearing on the future. Writes Ben Carlson, director of Institutional Asset Management at Ritholtz Wealth Management:

Being a student of market history can be helpful in a number of ways:

  • It can help you prepare for a wide range of outcomes.
  • It can show you how human nature can take things to extremes.
  • It allows you to think probabilistically about the future based on present circumstances.
  • It aids in the expectation setting process.
  • It proves almost everything in the markets is cyclical.

But studying market history does not:

  • Help you peer into the future.
  • Tell you exactly how investors will react under certain conditions.
  • Show you how to avoid overconfidence.
  • Take into account the fact that markets are constantly evolving.
  • Teach you how to handle situations that have never happened before.
  • Give you the map to future market returns.

Being an informed investor is important, but there’s no statistic that will tell you what the market is going to do next. Embrace the uncertainty.

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