Below is a chart of labor costs (red) versus corporate profits (blue).
A clear pattern emerges from the chart above. Profits rise after a recession as labor costs fall. When the labor market reaches capacity, profits fall as labor costs rise. When labor costs rise, the Federal Reserve raises interest rates to tame inflation which causes the next recession. Around and around we go in an endless loop. Ecclesiastes 1:9 describes it like this, “What has been will be again, what has been done will be done again; there is nothing new under the sun.”
Since 2015 employee wages have been rising as the labor market tightens. We also have corporate earnings falling. It is no coincidence that in Q1 2015 earnings began falling. We now see that it was rising employee wages that caused this.
I warned about the microeconomics of minimum wage hikes back in 2015 on the weekly Saturday night show here:
Colin Twiggs makes the interesting observation that it may be possible for the Federal Reserve to avoid causing a recession if they react sooner with rate hikes before the labor market overheats. Mr. Twiggs thinks that the Federal Reserve must raise rates before labor costs reach 72% of net value added (left side of the chart above).
When the demand for higher wages takes corporate profits below 9% of net value added (right side of the chart above), the party is over, and it’s time to become a long-term bear and reduce exposure to stocks.