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An Economic Cornerstone Cliff-Dives

CAMS Weekly View from the Corner – Week ending 8/12/2022

August 15, 2022

Imagine you are running a business and you do some analytical work on how various measures are performing relative to the overall economics of your operation.  There may be a plethora of measures to run through but one sticks out so blatantly that it stops you in your tracks in light of its foundational importance relative to the health and vitality of your business. You realize, on a trend basis, you are producing less while simultaneously increasing the amount of labor to create this end result.  It is the trend basis part that stopped you in your tracks. Reduced to lunacy imagine you are about to start up a business with the sole intention of “….our goal is to produce less goods/services while consistently increasing the number of labor hours to do so…”  All would expect a short lived endeavor. It is safe to say your business, be it new or existing, will be looking at hard times when viewing the Profit & Loss statement?  Realizing labor costs are a significant line item in the Profit & Loss statement for a business when these costs grow consistently faster than the amount of goods/services being produced we can trust that profitability will be heading down.  If this directional trend continues long enough the viability of the business will be in question. Societies at Large Now let’s say this is occurring for a society/nation at large.  In this case, like your hypothetical business above, said nation is and will continue getting poorer as the process of real wealth creation and hence rising standards of living trend in the wrong direction. Reduced to simplicity and brevity, real wealth is created in large part by increasingly producing more goods/services with less Labor to do so.  For a nation experiencing such a backdrop it is said their society is increasingly more productive which is built on the shoulders of innovation and increased efficiencies through capital investment. In a general sense this is a reflection of companies within the society producing goods/services more efficiently, productively and hence profitably.  This process also in-turn affords them the ability to sell their wares into the market place at lower prices.  To dig briefly into the economic weeds; in light of the described positive wheel of Productivity, Unit Labor Costs move lower allowing for both larger pay increases to employees and lower prices to consumers.  Follow that thread and we see households win on both fronts with lower prices at the checkout along with higher wages at the workplace.  This creates a positive upward spiral of increased standards of living for society at large which is another way of saying a society’s real wealth is increasing.  Without positive Productivity, that wheel runs in reverse. For the previous 40 years the U.S. has generally met that labeling.  There were episodes along the timeline that our nation fell off the described positive train but would right itself.  Thus far in the previous year that has changed on a trend basis.

Last week the quarterly Labor Productivity results were released for the 2nd quarter of 2022.  Productivity for the 1st quarter had already come in negative while the 2nd quarter added to the negativity in a notable manner.  Three of the previous four quarters have come in negative – that’s a concerning developing trend. The above chart goes back to 1948 which is the inception of this important economic cornerstone measure.  Per our annotations we see the previous low point back in 1974 (red circle) was taken out to the downside with our red arrow (just below our yellow text box) highlighting our current reading of negative 2.5% Productivity.  Our larger red down arrow highlights the established trend over the previous year. In early 2021 we were seeing Productivity coming in at 4% positive while ensuing quarters have led us to our current all time low.  Similar to our above hypothetical business scenario the fact of negative Productivity is unsettling while it is the trend that is concerning.  A country that experiences negative productivity growth will be experiencing decreased standards of living given time on trend. Stock Market Productivity is a centerpiece of building profitability for businesses.  Consistently rising profit margins and net profits are the lifeblood for increasing the value of a business.  When increasing both measures – in the case of publicly traded companies within the stock market – market participants are willing to bid up their shares in light of the profitability trend.  Importantly, participants also need to see a relatively clear path ahead for X business to continue with increasing profits. The above (chart) depicts the negative storyline unfolding for Productivity within the U.S. Business sector.  This is important for the nation at large (foundation piece of rising standards of living) for individual households (foundation piece for rising wages and lower consumer prices) and for the business sector (key ingredient to raising profit levels while offering products and services at lower prices.)  In addition, this is important to the investor class as this foundation piece is a key ingredient in making public companies more valuable in light of consistently increasing their profit margins and overall profits. Negative Productivity that is trending as such offers a poor collective backdrop on the increasing profit front for the stock market as a whole.  This is yet another indicator suggesting our stock market may be challenged for some time to come.  In addition, this also offers price inflation along with real wages (wages net of price inflation) will continue to offer challenges. As offered, negative Productivity, in particular on a trend basis brings all segments of society downstream financial health issues. I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis


H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.

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