The U.S. unemployment rate has fallen to a level where, at long last, significant wage growth is the most likely scenario in the months ahead. The accompanying chart shows that employment and wages have reached an inflection point that has historically indicated sharply stronger pricing power for labour.
Profiting from this trend can be tricky for investors. In the retail sector, for instance, profit margins are thin. The expense of paying higher wages can fully offset the benefits of higher revenues from wealthier customers.
A close look at the performance data for U.S. equity market sectors compared with wage growth over the past 14 years shows that consumer services and hotels, household products and food and beverage companies are the best ways for investors to profit from higher U.S. wages. Sectors that have performed poorly when wages climb include financials and – no surprise – auto stocks, where margins are already crimped.
In terms of individual consumer services stocks there's another issue. The high correlation between the sector and wages is primarily driven by McDonald's Corp. and Yum Brands Inc. Both of these companies earn substantial revenue outside of the United States, 65 per cent and 36 per cent respectively, which may be adversely affected by slowing global growth outside the United States. Chipotle Mexican Grill Inc. may be the best bet in the sector, but the stock's current price-earnings ratio of 51 times means investors should be careful.
Once McDonald's and Yum Brands are removed from the equation, household product stocks look more promising than consumer services as a way to play potential U.S. wage growth. Companies such as Clorox Co. and Colgate-Palmolive Co. have high sensitivity to wage growth, are reasonably priced (although valuations are slightly more expensive than historical averages) and pay decent dividends. (Procter & Gamble Co. is also a potential investment candidate in the sector, but I generally prefer not to recommend stocks that Warren Buffett is currently selling.)
The ongoing slide in the Canadian dollar and weakness in commodity prices makes this strategy a topical one for domestic investors. Ideally, the lower-risk consumer staples stocks will allow investors to benefit from both the strengthening greenback and rising wages.
Even if the U.S. economy disappoints, again, and wage growth does not materialize as expected, investors in household product stocks should be partially insulated against steep losses by the dividends and slow conservative projections reflected in stock valuations.
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