Some market observers have argued that faster economic growth in the U.S. means that inflation may be coming soon. However, in the past, economic growth has come with increases in employment, labor participation rates and wage inflation. In this cycle, wage inflation has not occurred as productivity gains have kept US average hourly earnings of production workers stable. Also labor participation rates have declined, suggesting that there is still slack in the labor market. Discouraged workers may have left the labor force temporarily but want to re-enter it as soon as hiring picks up. Such slack will also temper wage inflation.
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Citi analysts, led by Tobias Levkovich, believe that worries about inflation triggered by the Federal Reserve making more money available in the economy are overblown. The velocity of money has not improved, suggesting that banks are still not lending enough. Credit availability is still limited to the best borrowers.
From the chart above, note that the share of employment of firms with less than 250 employees has declined to 47.6% in 2010 while the share of employment of firms with more than 250 employees has remained steady since 2007. Small businesses, however, still employ a significant part of the U.S. labor force. Such firms do not have as much access to credit compared to their larger counterparts. Large and giant banks have a 46% share in small business lending despite having an 80% share of bank assets. SBA loan proceeds under section 7(a) program, where banks, savings and loans, credit unions, and other specialized lenders participate with SBA in providing loans to small firms, have declined $179 million year over year ending on January 10, 2014 according to SBA’s weekly report.
REITs provide income and property value appreciation
Overall, Citi analysts believe that large jumps in inflation are not coming up in the near term. Wage inflation will probably remain in check thanks to slack in the labor market, continued productivity gains, and soft global demand. However, if investors want to protect themselves against upside inflation risks, REITs may be worthy of consideration. Some investors are concerned that rising interest rates and inflation may erode REIT prices. Citi analysts counter that view by highlighting that rising property values may offset the temporary impact of rising interest rates. Property values will be supported by higher rents, accelerating demand for accommodation and availability of capital. Furthermore, Citi analysts note that the difference between REIT dividends and 10-year U.S. Treasury yields (which remains favorable to REITs) is far more important for REIT prices than the overall level of interest rates. Citi’s Michael Bilerman estimates that REITs may gain between 5% and 10% on a total return basis for 2014.