Wall Street’s Ugly Future

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T.S. Eliot was wrong. The world really does end with a bang.

Especially when we’re talking about the world of “nonexistent inflation” — a world mainly inhabited these days by mainstream economists and stock strategists.

Don’t believe me? What were those loud crashes I heard recently?

It was the sound of investors exiting en masse from Wall Street.

It’s all about three ugly words: higher labor costs.

Get used to those three words, because we’re going to hear them a lot more in coming quarters. And for the Federal Reserve and Wall Street — both bemoaning the lack of inflation in the economy — it’s a classic example of “be careful what you wish for.”

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The fast-growing Chipotle Mexican Grill chain, now with nearly 2,000 restaurants, is just the latest company to get hit by those three ugly words.

This time last year, workers’ wages represented about 21% of the cost for its tacos and burrito bowls. Last quarter, labor costs jumped to a little over 22% — an increase of roughly $40 million dollars. The chain expects those costs to go higher still through the end of the year.

Wall Street wasn’t happy, tanking Chipotle’s shares more than 10% in a few days’ time. And that’s just the start.

Start Spreading the (Bad) News

Take Wal-Mart, for example. The retailer’s stock was hit for a 10% (and counting) loss in the past few weeks.

Wal-Mart had promised to get its half-million strong workforce up to a minimum base wage of at least $9 an hour this year. It’s targeting $10 next year. The higher pay means $2.7 billion in new costs over the next two years.

The money has to come from somewhere. But the retailer can’t raise prices. Amazon, ALDI and dollar stores drain off plenty of business already.

So Wal-Mart made the cruelest cut of all, taking the money out of shareholders’ hides. “In fiscal 2017,” said the company on October 14, “this wage investment represents approximately 75 percent of our earnings per share reduction.”

Ouch.

Last week, PulteGroup — the nation’s third largest residential builder — said its sales declined 6% for the third quarter. Apparently, it has plenty of homebuyers. What it doesn’t have is enough workers to keep up with demand.

The CEO told analysts: “It’s clearly impacting our production. In general, we have to pay more labor.”

So here’s the takeaway: Step by step, higher wages are getting baked into companies’ business plans.

You see, it’s not just Wal-Mart or the fast-food chains.

It’s not just low-wage businesses in major cities (where $15 an hour is fast becoming the legislated target).

It’s everywhere.

Inflation’s Canned Heat

The Federal Reserve’s “Beige Book” reports has plenty of hints about this. The Beige Book comes out every six weeks or so and represents a collection of “on the ground” anecdotes collected by the central bank’s 12 districts.

  • In the Midwest, trucking companies can’t find enough drivers, so they have to “up” their pay packages.
  • In New York, employers of many stripes are raising wages in order to attract “skilled and less skilled workers.”
  • In San Francisco, the Fed’s researchers noted the effects of the $15 minimum wage law “began to filter through to the retail sector and resulted in increased wages for some lower-skilled workers.”

Some today, sure — but a lot more tomorrow.

By now, you might be saying, “OK, if wage pressures are building, why did the most recent Employment Cost Index report — the government’s quarterly measure of wage pressure — have the smallest increase in 33 years?”

It’s a good question. For the answer, you have to remember that each month, thousands of baby boomers retire and leave the workforce. As the oldest members of America’s active working population, they tend to be better paid too.

So as each boomer retires, he or she is replaced by someone younger … And that younger person, generally speaking, is going to have a lower salary.

The statistical result, as JP Morgan’s Chief Global Strategist David Kelly recently addressed in Barron’s, makes overall wage growth look anemic. Yet these same pressures suggest “wage gains will probably increase in the months ahead for cyclical reasons as the unemployment rate falls further, more part-time workers find full-time jobs, and attitudes about the economy improve.”

That’s great news for any worker.

It’s terrible news if you’re an investor.

Why? Well, the Wall Street script says inflation is dead. End of story. But what if it’s not? Stocks — not to mention bonds — haven’t even begun to price in such a possibility.

Your Inflation Protection

So where does that leave us? It comes back to gold.

Just like there’s a reason why the price of the metal has been going down in price since 2011 (too much supply, too many cheerleaders and a global deflationary outlook), there’s also a reason why it’s up more than 7% since July (and I believe has well and truly bottomed).

The buyers and sellers who make up the global gold market sense a change in the monetary and economic winds — a faint breeze heralding the arrival of a larger inflationary tempest just over the horizon.

Kind regards,
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JL Yastine
Editorial Director, The Sovereign Society