Unemployment, wage inflation & the ongoing puzzle

The link between unemployment & inflation

Historically, inflation has tended to be correlated to the strength of the labour market. As unemployment decreases, the pool of available labour shrinks, enabling workers to demand higher wages. This feeds through to the overall price level, putting upward pressure on inflation. Today, however, we are seeing a puzzling global macroeconomic backdrop as unemployment has been falling, but wage growth has remained stagnant for some time and inflation has been dull. Now, we know that in the UK, inflation has been ‘imported’ through movements in the oil price or weak Sterling. However, from a global perspective, why has wage growth not occurred as unemployment has fallen so low? We believe the issue is down to underemployment.

Underemployment

In the US and the UK, unemployment has consistently fallen since the heights of the financial crisis. Theoretically, an economy enjoying near-record employment levels should also be enjoying a decent level of wage growth. However, despite unemployment currently standing at multi-decade lows of just 4.5% in the UK, average weekly earnings growth has failed to pick up and has actually been on a downward trend since the middle of 2015. Last month saw just 1.8% growth year-on-year, well below inflation, which means that UK wages have actually fallen in real terms. We believe this trend is due to underemployment.

Unemployment & wage growth

Source: Office for National Statistics (ONS), as at 31/05/17.

The labour market & interest rates

As well as unemployment, interest rates are also at historic lows, with the current base rate in the UK amounting to just 0.25%. This has put tremendous pressure on savers during the past decade, as they have struggled to gain a return on their cash, particularly when approaching or in retirement. We believe this has contributed to the boom in older-worker employment, either through delayed retirement, or part time work as many pick up a few hours a week to supplement their incomes. Indeed, a paper from the Institute of Fiscal Studies from 2014 highlighted that employment rates for both men and women age 65-69 were at their highest levels since 1974 and were continuing to grow. Although this has given added flexibility to some parts of the economy, it has also meant that there is also greater supply of full time workers, helping to put downward pressure on wage inflation.

No. of people over 64 and economically active in the UK (000s)

Source: Office for National Statistics (ONS), as at 31/05/17.

As well as becoming more economically active, people are also retiring later in the UK. Even since 2010, ONS statistics highlight that the average retirement age for women has jumped from 60 to 63.5. In the US, however, the retirement age of women has remained consistent over the last few years at 66. Nonetheless, the number of employed persons in the US is the highest it has ever been and the number of workers who work part-time but would rather be full-time is still much higher than pre-2008. This highlights the slack still apparent within the US labour market and helps explain why average wage growth there has been similarly poor.

Domestic outlook

Overall inflation has rolled over in the last month, both in the UK and globally, as lower crude prices feed through to the petrol pump, giving some respite. However, we see little upside for average wage growth increases in the short-term in the UK, given the political and economic uncertainty surrounding both the government and the on-going Brexit negotiations. With pressure now also being applied on the disposable income of the average UK consumer through negative real wage growth, the outlook for many domestic facing stocks is far from rosy.

Therefore, the exposure of the CF Canlife UK Equity Income Fund to discretionary consumer spending is extremely limited. Instead, we maintain a quality bias within the portfolio, with a focus on overseas earners and a more defensive positioning than in recent years. This includes holdings in companies like Reckitt Benckiser, the consumer goods giant, which makes 93% of its sales outside of the UK. We also remain very much focused on our policy of pursuing unusual dividends. An example here would include DS Smith, a packaging company, which has recently made its first foray in to the potentially lucrative US market.

Looking at the market overall, sector correlations are high and the market is not being driven by company fundamentals to any great extent. Consequently, despite some selective opportunities, we are not particularly inspired at a broad market level at present. Therefore, we have maintained our defensive, quality bias, whilst also seeking exposure to businesses not reliant on UK plc. The CF Canlife UK Equity Income Fund has returned of 5.57% year-to-date, versus the FTSE All-Share Index return of 5.50% (as at 30/06/17). Over the last three years, the Fund has delivered a 27.83% gain, outperforming the benchmark’s 23.87% rise and ranking in the second quartile of the IA UK Equity Income sector.

 

Important Information

Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate.

*Source: Performance figures from Morningstar, bid to bid, with net income re-invested for C share class. Sector is IA UK Equity Income. Benchmark is FTSE All-Share.

The information contained in this document is provided for use by institutional investors, professional investors and professional advisers and is not for onward distribution to, or to be relied upon by, private investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and are subject to change at any time without notice. The contents of this article are not intended as investment advice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com.

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CLI00855 Expiry 21 July 2018

Craig Rippe

Craig Rippe

Head of UK Equities

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