Rising wages are good for workers, but they’re not great for corporate margins—or for the stocks of companies that will have to pay considerably more in the future.
And make no mistake: Wages are heading higher. When Federal Reserve Chairman Jerome Powell testified before Congress last week, worker pay was a prominent topic of conversation. Average hourly wages have been growing at a clip of about 3% year-over-year, and some observers worry that it could lead to higher inflation. Powell isn’t one of them. “Wages are growing at a level that makes sense,” he said in his testimony. “We don’t find it troubling from an inflation standpoint.”
One reason Powell can afford to be relaxed is that unemployed Americans continue to return to the workforce. With the labor-force participation rate at 82.4%—below its 2000 peak of 84.5%—there’s still room for another two million people to get jobs, DataTrek co-founder Nicholas Colas wrote in a note last week. “If labor-force participation increases...the Fed can theoretically keep rates lower since marginal labor will keep wage inflation in check,” Colas said. “This also increases the incomes of marginalized Americans who might otherwise not find gainful employment.”
Still, companies that have large workforces might have a problem. S&P 500 profit margin’s are expected to decline this year, Goldman Sachs strategist Ben Snider noted in a February report. And while that’s not just the result of wage pressures—tariffs and slowing sales growth are having an impact—higher pay is becoming an issue. Some 58% of respondents to the National Association for Business Economics’ most recent survey said that labor costs were rising, but only 19% said they were charging customers more.
“As wages rise, companies will be forced either to accept lower profitability or to attempt passing through the costs via higher prices,” Snider wrote. He recommends owning a sector-neutral basket of companies with low labor costs relative to sales, one that includes PayPal Holdings (PYPL), tech titan Alphabet (GOOGL) and biotech giant Biogen (BIIB).
In fact, the entire biotech sector may be a good place to look for companies that are less impacted by rising labor costs, according to Canaccord Genuity analyst Martin Roberge. Wages in the biotech industry are growing just 0.3% year-over-year based on their three month moving average, he noted, while pricing power has been growing faster than pay. “Mixing pricing power and wage inflation, our biotech margins-support gauge signals healthy profit margins in 2019,” Roberge wrote in February. “As a result, relative [earnings-per-share] strength should stay solid and drive biotech outperformance.” He recommends owning the iShares Nasdaq Biotechnology ETF (IBB).
Other industries aren’t as insulated. Retail, where wages have been consistently low, could see wage pressures, Nomura Instinet analyst Simeon Siegel said. Jobs are shifting from the stores, where pay is lower, to the warehouses and logistic centers, where pay is higher, he said. Minimum wage increases and greater competition for workers is also pushing pay higher.
According to Siegel’s data, companies in off-price retail— TJX (TJX) called out rising wages as an issue in its earnings call last week—and teen retailers like Urban Outfitters (URBN), Abercrombie & Fitch (ANF), and American Eagle Outfitters (AEO) could be most at risk from future wage increases. Others, however, are more immune. Nordstrom (JWN), Costco (COST) and Tiffany (TIF) already pay some of the highest wags in retail and should be less impacted as wages rise, Siegel said.
He’s a fan of Capri Holdings (CPRI)—the former Michael Kors—in particular, though not just because it already pays above-average salaries. Siegel said the company is being traded like it is a collection of distressed assets, even though that’s not the case. Siegel also noted that management is confident about its ablitity to stabilize the Michael Kors brand and increase profits and sales at Jimmy Choo and Versace. Siegel has a Buy rating on Capri stock, and expects it to trade up to $76, a 64% gain from last Friday’s close of $46.81 per share.