U.S. stocks could stumble as labour finds its feet

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A rebounding U.S. labour market has long been looked to as a critical boon to a sustained U.S. economic recovery. But it may be an obstacle for the stock market.

In a research note Wednesday, Capital Economics senior market economist John Higgins noted that labour's share of total income in the U.S. economy "grew considerably" in the 2012 fourth quarter, up nearly 5 per cent on an annualized basis. "This was because the growth rate of unit labour costs (4.5 per cent) exceeded that of selling prices, which was minus 0.4 per cent," he explained.

While he doubts labour's share of the economy is going to continue to expand so rapidly, he suggested that labour's share could well continue to expand "over the next couple of years" as the jobs market continues to gradually strengthen. Indeed, he said, "a rise in the share is long overdue from a cyclical perspective."

What does this have to do with the stock market? Well, Mr. Higgins said, an expanding share for labour in the U.S. economy has historically been accompanied by a corresponding decline in capital's share of the pie – and that includes, more to the point, corporate profits. (Makes perfect sense – if labour income is expanding, it's typically doing so at the expense of companies' bottom lines.)

"In the past 60 years at least, the stock market has tended to fall not long after labour's share has troughed," he wrote.

"To be clear, the outlook for labour's share of income is not the driving force behind our predictions for the U.S. stock market. We expect quantitative easing and developments in the euro zone to play more prominent roles in determining the near-term fate of equities," Mr. Higgins said. "However, we do think that a squeeze on profit margins will become an increasingly important issue as the year progresses.

"Our forecast remains that, after peaking at 1,550 around mid-year, the S&P 500 will end 2013 at 1,500."