Like many equity market strategists, Gerald Minack looks back on 2013 and scratches his head.  “Equities did better than I expected,” he said.

In his recent investor letter of December 30, 2013 Mr. Minack acknowledges two primary “mistakes” he made following fundamentals in 2013. “First, equity markets ignored macro weakness,” he said.  “Second, US employment ignored GDP weakness.”

2013 could be said to be a market environment in which artificial central bank stimulus drove stock market performance more so than macro fundamentals.

“This has been a weak GDP recovery by historical standards; it has been a weak employment recovery by historical standards – but it has been a strong employment recovery given the weakness in GDP,” he noted.  “The fact that weak growth did not slow employment growth was, in my view, critical to the market’s indifference to the apparent run of disappointing macro data.”

Minack notes weak labor productivity

Minack notes the strength in hours worked in the face of soft GDP growth implies weak labor productivity, which has always been a cyclical component.  “Three year average productivity growth is now near the lowest seen outside a recession.”

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Minack notes with amusement that weak productivity growth, normally a stock market negative, worked to help equities in 2013 by damping the effect of soft GDP growth on payroll growth, but notes with concern a coming change.  “Weak productivity growth in 2014 may unsettle equities if it causes capacity constraints to bite – threatening either unexpected inflation, or a ditch-forward guidance catch-up by the Fed.”  Minack disagrees with the Fed, which he says sees employment weakness as largely cyclical.  “I think there is growing evidence that much is structural,” he said.

Rise in real wages with productivity soft

“For investors it’s important that real wages are rising with productivity soft. Margins are largely dictated by how much output firms get from their workers versus how much they have to pay them. Rising margins over the past 30 years were not due to strong productivity; it was because worker pay rose less than productivity (Exhibit 8). We are now getting a hint that this may reverse (that is, real wage growth running ahead of productivity). If confirmed, it means that margins may fall,” he noted with concern.  “If the Fed behaves as if trend growth is unchanged then – for the first time in years – markets may next year start to worry more about inflation than growth.”

In short, Minack’s note indicates that markets may respond to different economic factors in 2014 – which might not benefit all long equity positions.  It will certainly be interesting to watch unfold.

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by Mark Melin