Disturbing trends

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George Kessarios
Chief Economist & Fund Manager

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Disturbing trends
As the chart below shows, nonfarm labor productivity in the US has been drifting downwards for the past 2 years. In fact, the 2.5% Y/Y decline in labor productivity is the largest decline in the series since records began in 1948.

By default, increases in hourly compensation increase unit labor costs, and increases in productivity tend to reduce them. Nonfarm unit labor costs increased 10.8% for Q2 reflecting a 5.7% in hourly compensation and a 4.6% decrease in productivity.

Unit labor costs in the US increased 9.5 percent over the last four quarters, the biggest rise since the 10.6% increase in the first quarter of 1982. BLS calculates unit labor costs as the ratio of hourly compensation to labor productivity.

Obviously listed companies are more productive than the US economy as a whole, however when labor and input costs rise, it will pressure even them. And when the decline in Y/Y labor productivity is the biggest print since 1948, this might mean something that we are not fully grasping yet.

Please note that the world is currently experiencing a plethora of issues that could affect long term productivity trends and profitability.

High energy prices – Not just because of the Russian- Ukraine war, but also because of a rush towards clean energy production and ESG standards.

Political tensions – While tensions between China and the US have been going on for several years, we now have grievances between China and Taiwan. Also, relations between Russia and Western counties are not expected to normalize soon. As a result, many companies are diversifying supply chains or are relocating them in their home countries. New terms such as onshoring and friend-shoring are coming into play. But this relocation of supply chains will not happen overnight and might take a decade or more to play out. Supply-chain relocation, and building new manufacturing facilities are both expensive and inflationary

Covid Pandemic – For the most part Covid is behind us, but China is still struggling. There is also the chance that a new pandemic arises that might be worse than Covid. The recent monkeypox outbreak is a small example, even if it is not a global threat as Covid was.

All the above issues increase input costs as well as labor costs and reduce overall productivity. And while the likelihood of a major war between Russia and the West, or hostilities with China are perceived to be low, nevertheless the market prices these possibilities in the multiple.

The bottom line is that, while there are many factors that have contributed to the weak productivity numbers in the US, we must ask ourselves if the current geopolitical skirmishes are something of a longer-term trend that might act as a tailwind for global growth and profitability from now on.

This is very difficult to answer, but if the answer is yes, risk assets might be reprised with a lower multiple. And this is something that investors need to weigh very careful going forward.

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