February 4, 2019
Key Takeaways
- The ClearBridge Recession Risk Dashboard saw a fifth signal change to yellow in January, however we maintain our outlook of expansion for the U.S. economy in the coming year and the overall signal remains green.
- Wage Growth has accelerated over the last several months, which could lead to pressure on corporate margins and cause companies to raise prices.
- We believe it is important to look beyond energy to include chemicals and other industrial materials when evaluating Commodities.
Financial and Inflation Measures Now Signal Caution
The ClearBridge Recession Risk Dashboard experienced one change at the end of January, with Wage Growth moving to yellow. This follows three changes the prior month: the Yield Curve, Credit Spreads and Commodities signals all worsened from green to yellow. Importantly, these changes do not alter our outlook for the U.S. economy over the coming year, with the overall Recession Risk Dashboard continuing to signal expansion. Having previously written about both the Yield Curve and Credit Spreads, this month we will focus on the two inflation-related indicators: Commodities and Wage Growth. While lower energy prices are likely to keep headline inflation in check, we believe core inflationary pressures (inflation excluding more volatile food & energy) are building.
Exhibit 1: ClearBridge Recession Risk Dashboard
As of Jan. 31, 2019. Source: ClearBridge Investments.
Wage Growth: Recent Acceleration Could Lead to Higher Prices
Wages represent the greatest component of income for most Americans, and higher wages can be good for consumption and the economy broadly as individuals have more dollars to spend. However, rising wages can also put pressure on corporate margins if productivity doesn’t keep pace, ultimately leading to inflationary pressures with companies having to raise prices to maintain profitability.
Wage growth rising above 4% on a year-over-year basis has predated each of the last three recessions over the past three decades, as shown in Exhibit 2 below. While wage growth has not yet reached this level, wage gains have accelerated over the past several months. Specifically, wage growth ranged from just below 2% and 2.5% beginning in the early part of the current recovery (around 2011) through the end of 2017. Last year saw wage growth in the 2.5% to 3% range for much of the year, before moving into the 3% to 3.5% range as cold weather set in. This type of climb higher has historically come well in advance of a recession. ClearBridge’s research shows that the pace of acceleration in wage growth relative to recent trends is an important dynamic and something we will be monitoring closely in the coming months. While current wage growth levels are not yet consistent with those experienced just ahead of past recessions, they are at levels consistent with a yellow signal on the ClearBridge Recession Risk Dashboard.
Exhibit 2: Average Hourly Earnings
As of Jan. 31, 2019. Source: Bureau of Labor Statistics, National Bureau of Economic Research (NBER), Bloomberg. Note: Production & non-supervisory workers only prior to June 30, 2009, all employees after.
Commodities: The Importance of Looking Beyond Energy
When many individuals think about commodities, they tend to first think about oil. This is logical given the role oil plays in daily life, with the average American visiting a gas station once a week. However, when it comes to gauging the health of the economy, there are a number of important commodities investors can look to beyond oil. While energy is an important input for the U.S. economy, energy intensity (the amount of energy consumed per dollar of GDP) has fallen steadily since the 1970s according to the Energy Information Administration (EIA). This fact, combined with substantially higher domestic energy production, has transformed the importance of energy in the context of the U.S. economy.
Several broad commodity indexes exist, including those published by the Commodity Research Bureau (CRB), Bloomberg, and S&P Dow Jones among others. However, these benchmarks tend to be heavily weighted to energy-related commodities. For example, the CRB index is made up of 23% crude, which is about four times the weight of the next-largest commodity. An additional 16% of the index is heating oil, gasoline, and natural gas, meaning nearly 40% of the total is comprised of energy-related commodities. As goes energy, so goes most commodity indexes. As a result, we believe it is important to look at more than just the price of crude when thinking about commodities in an economic context.
In order to do so, we monitor an array of commodities that are used as inputs across a variety of sectors, including lumber, steel, copper, oil and, perhaps most importantly, chemicals. Chemicals are a key input for a wide array of products and businesses across the U.S. economy. Chemicals are typically positioned early in the supply chain, meaning that changes in use can help identify emerging trends in economic activity. Additionally, chemicals are pervasive across our economy, going into all sorts of end-products ranging from plastics to household items such as cleaning products to technology hardware like cell phones to foods like baking powder.
Because of this, we believe looking at a wide array of chemicals can help paint the most complete picture. The American Chemistry Council’s Chemicals Activity Barometer is one such indicator which incorporates an array of datapoints including chemical stocks, prices, hours worked, and other broader leading economic measures. This metric looks across different types of chemicals and sectors and includes chlorine, other alkalis, pigments, plastic resins and other important industrial chemicals. This indicator typically falls by at least 5% during a recession, as shown in Exhibit 3 below. While it is not yet at that level, it has been trending lower over the past several months and crossed into negative territory with the most recent reading.
Exhibit 3: Chemicals Activity Barometer
As of Jan. 31, 2019. Source: American Chemistry Council, NBER, Bloomberg.
The decline in the Chemicals Activity Barometer was a significant contributor to the overall Commodities signal turning yellow last month, although lower copper and steel prices played a role= as well. By contrast, oil and lumber prices have recently turned more positive, making commodities something of a mixed bag at present.
As we outlined in our December blog, the aggregate signal of the ClearBridge Recession Risk Dashboard takes time to worsen from a current green signal to yellow and eventually to red. Despite an increase in the number of indicators flashing yellow, we maintain our view of overall health for the U.S. economy.- See more at: https://www.clearbridge.com/news/blogs/2019/recession-indicators-inflation.html#sthash.Gdsi22OS.dpuf
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