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Labour markets and their impact on returns

Labour markets and their impact on returns
August 22, 2019
Labour markets and their impact on returns

The UK economy contracted by 0.2 per cent in the second quarter, while a decline in export orders meant that Europe’s largest economy, Germany, also slipped into negative territory during the period. And some of the leading indicators don’t provide much encouragement, either, especially when taken in combination.

The CBOE Volatility Index (Vix) suggests that option traders anticipate a 5.1 per cent decline in the S&P 500 over the next month. Meanwhile, the copper price, one of the most closely followed input indicators, is down by around 12 per cent since the end of February.

If that wasn’t chastening enough, further anxiety was triggered by news that yields on two-year Treasuries are surpassing those on 10-year debt instruments. We’ve been here before. The yield curve was flattening through December and the bond yield inversion was extended to short-dated three-month T-bills midway through March – something of a rarity.

The phenomenon has heralded both recession and increased market volatility in the past, but in a nutshell it means that businesses that rely on short-term financing are hamstrung through increased debt servicing costs. Banks also cut back on loan approvals, while consumer spending is constrained as credit costs increase.

Leaving aside yield inversion, could the performance of the UK benchmark be telling us something? The FTSE 100 closed out the week 7 per cent down on the year-to-date high of 7,686 points. The index is now broadly in line with its 200-day moving average, although 7.4 per cent adrift of its 50-day moving average, suggesting it’s in a downtrend.

However, the view that stock market performance is a reliable leading indicator has gone out of fashion. You might argue that share prices reflect earnings expectations, which, in turn, have a bearing on changes in spending patterns brought about by changes in perceived wealth – the so-called 'wealth effect'. By extension, this affects the level of aggregate demand in the economy, but it’s far from certain what causal relationship exists, if any. It’s worth noting that the global stock market collapse on ‘Black Monday’ in October 1987 didn’t prefigure a pronounced economic contraction.

It may be that recent data from the Office of National Statistics (ONS) on the UK jobs market provides a more illuminating insight into where the economy is headed. Unemployment numbers grew by 31,000 to 1.3m in the second quarter, though the number of people in work climbed to a record high of 32.8m. Job vacancies, though still high by historical standards, have been in decline since the start of the year, while wages rose at their fastest rate in 11 years.

When combined, these metrics could suggest that the UK labour market has reached a tipping point, with real wages on the rise, partly a reflection of the impact of the national living wage, but mainly because it’s been a seller’s market due to a tight employment balance. Employers might already have become more reluctant to take on new staff due to rising wage bills, to say nothing of Brexit.

This is partially borne out by recent updates on UK performance from recruiters. PageGroup (PAGE) revealed a 0.3 per cent decline in gross profit at the half year, while Hays (HAS) recorded a 6 per cent contraction in private sector net fees. The outlier was Robert Walters (RWA), which recorded a 1 per cent increase in UK net fee income.