Nothing is permanent, but markets are trying to discern whether a series of trends emerging from the pandemic will turn out to be transitory or if they will persist for years.
For most of the last decade, economists have been obsessed over the three D’s: debt, demographics and digitalization. Now a fourth “D,” deglobalization, threatens to upend the status quo of the past 40 years.
When it comes to the future trajectory of inflation and interest rates, these forces are at cross purposes. Demographics and digitalization are deflationary, while burgeoning debt and deglobalization should theoretically be inflationary.
Then there is a shifting political climate. In personality, President Biden and former President Trump could hardly be more different. But both leaders went out of their way to appeal to marginalized American workers and to make flagging middle-class wages a major issue.
This shifting narrative is prompting people like GMO co-founder Jeremy Grantham to speculate that this change could drag many aspects of American life “back into the 20th century,” when stock prices on Wall Street weren’t the only thing that mattered. Grantham expects the balance of power between capital and labor to drift partially back toward historical parity in the coming decade. A major driver of this will be the aging populations in the developed world and China.
Advanced economies are already running low on workers. In America, retirements surged more than 300% from 2019 to 2020. Generous fiscal stimulus and pandemic-driven dislocations between unemployed workers and businesses trying to reinvent themselves make it almost impossible for many small and medium-sized businesses to fill positions today, Grantham notes.
Retailers, for instance, are reporting resistance by former workers to return to work for what merchants expect to be a busy fall and Christmas season. As more flexible, work-from-home options involving less social contact expand, retailers may have to pay up to lure former employees back to the stores.
Can Capital Maintain Control?
Thirty years ago, employers were in the catbird’s seat in their relationship with workers, and that played an undeniable role in the remarkable appreciation in equities.
An expanding, global labor market gave corporations a huge onetime advantage that weakened labor in the developed world. “Five hundred million Chinese were joined unexcitedly by 200 million Eastern Europeans [who had been] pretending to work for their Communist” masters, Grantham explains.
When these populations joined the global workforce, American workers saw sharp declines in their negotiating power. Wages in the U.S. rose only 10% after inflation in the last 50 years, Grantham notes. In contrast, real wages climbed more than 60% in both England and France, a little noticed fact. This permitted American corporations in particular to double their profit margins over a half century.
Corporate profits, the lifeblood of the equity markets, were the subject of an April 2021 paper by PGIM chief economist Nathan Sheets and his associate George Jiranek that largely confirmed Grantham’s argument. The PGIM economists find that employee wages as a share of GDP have fallen from 56% to 53% since 2000, while “the share of capital has surged from 18% to 21%. Stated differently, earnings that now amount to roughly $600 billion a year have been transferred from labor to capital.”
Sheets and Jiranek note that since the 2007-2009 financial crisis this trend has only accelerated. Unlike Grantham, however, they expect robust corporate profits to hold up.
By the end of 2022, they say profits “are likely to have bounced roughly 20% to 25% relative to their [pre-pandemic] 2019 levels. And we see incremental further gains in 2023.” They concede, however, that a corporate tax hike by the Biden administration could divert a chunk of those profits.