Market Commentary 8/23/22

Update on Productivity

We have been watching productivity, labor costs and efficiency in an attempt to determine how decreases in efficiency, combined with rising labor costs may impact earnings.

We observed a trend not seen in decades – declining labor productivity and rising labor costs. Labor productivity, which is measured as economic output per hour worked, declined 2.5% year-over-year during the second quarter. This 2.5% decline is the largest in the data series, which began in 1948. Additionally, hourly compensation rose 6.7% year-over-year as a tight labor market drove strong wage growth.

A look at the underlying data provides additional context on the decline in productivity. Total output rose 1.5% compared to the same quarter a year ago, while hours worked rose a larger 4.1% year-over-year. The data may indicate workers produced more goods and services less efficiently.  One potential explanation is pandemic-related issues, such as remote work and inflation, make the process of measuring productivity more difficult and distort the data.  Thematic changes may also explain the productivity decline. The labor market experienced significant turnover during the pandemic, and it takes time for workers to learn new jobs. For example, a major airline CEO pointed to labor turnover as a cause of the airline’s recent operational issues: “Since the start of 2021, we’ve hired 18,000 new employees, and our active head count is at 95% of 2019 levels, despite only restoring less than 85% of our capacity. The chief issue we’re working through is not hiring, but of training and experience.”

Additionally, capacity constraints may also be weighing on productivity. The capacity utilization rate, which measures the amount of potential output that is being realized, was 80% during June 2022. The peak utilization rate over the past 20 years was approximately 81%, suggesting businesses may be running up against the limit of how much capacity they can use efficiently.

The combination of declining productivity and rising compensation costs is worrisome, and it remains to be seen whether it is a short-term phenomenon or start of a longer-term trend. We will be monitoring the rest of this year to see if decreased efficiency and rising labor costs negatively impact profit margins.

We also wanted to comment on housing again this week. Existing home sales continue to decline with an approximate 6% decline month-over-month.  Also, home inventory levels continue to increase. Housing market data is another area we will be watching closely throughout this year.