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Economic News & Analysis—March 8, 2013

Payrolls, profits, and the Fed

By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist

The U.S. Department of Labor reported today that nonfarm payrolls rose 236,000 in February and the unemployment rate dropped to 7.7%. December’s payroll gains were revised up 23,000 while January’s were revised down 38,000. The average workweek in February increased 0.1 hours and average hourly earnings increased by 4 cents. On the whole, this report was much better than I was expecting.

During 2012, nonfinancial corporate profits increased 22% while payrolls grew 1.6% and wages grew 1.6%. Many people may be wondering when labor will have its day. It could be a while.

While wages have been growing exceptionally slowly, the cost of benefits (for example, health care and retirement) has been growing more rapidly. As a result, total compensation has increased more rapidly than the wage data suggest. It’s still much slower than profit growth. However, this trend isn’t abnormal. If you look at year-on-year changes in corporate profits and year-on-year changes in payrolls, profits increased approximately 62% of the time while payrolls increased 79% of the time. Corporate profits are much more variable than wages and payrolls as equity owners absorb a great deal of risk in terms of the ups and downs of the economy.

For the balance of the year, the outlook for the unemployment rate seems to be one of a slow grind lower. However, I’m somewhat concerned about what could happen toward the end of the year and as we enter 2014. The latest Beige Book from the Federal Reserve (Fed)—a collection of qualitative data about U.S. economic conditions—made five different references to the Affordable Care Act. Four of those references mentioned how it was already causing small businesses to hire fewer workers. Another reference suggested some health care providers are expecting better revenue growth as a result of the legislation. I think we’ll need to see significantly stronger economic and sales growth for small businesses to motivate them to hire more than the bare minimum.

For investors, the payroll data may trigger further increases in Treasury yields and additional support to the equity markets. Better-than-expected payroll growth is almost always positive for equities. The one danger is that investors may expect that a more rapid reduction in the unemployment rate will push the Fed to end its asset purchase program sooner than originally anticipated. At the March 19–20 Federal Open Market Committee (FOMC) meeting, the FOMC members will craft their new economic projections. If those projections show the unemployment rate dropping below 6.5% or inflation rising above 2.5% sooner than previously projected, that could trigger an increase in Treasury yields as investors will expect the Fed to pull back on its monetary easing program.

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