Fed wants workers to get paid more

In the U.S., corporate profitability will likely decline as the Federal Reserve supports a tighter labour market and higher wages.

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“Corporate profit margins are fairly dependent on labour cost,” explains Luc de la Durantaye, first vice-president of Global Asset Allocation and Currency Management at CIBC Asset Management. He manages the Renaissance Optimal Inflation Opportunities Portfolio.

“The higher the labour cost, the more downward pressure you have on profit margins,” he notes. And, “the U.S. probably has one of the tighter labour markets,” compared to other global regions.

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What’s more, the Fed’s aiming to further tighten the American labour market, says de la Durantaye. “Its policy is aimed at raising labour compensation and, as a result, at indirectly lowering corporate profits in the U.S., at a time when it’s one of the more expensive equity markets that we see.”

So, “while the U.S. economy is doing well, [that’s] putting downward pressure on U.S. corporations and that’s something we should pay attention to.”

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Investors should focus instead on regions where corporate profits aren’t experiencing this same pressure, he suggests. “There’s still slack in the labour markets in Europe and Japan. So the profit margins there are less affected, [which] influences our mid- to longer-term preference for equity markets.”

“Emerging markets have some cyclical challenges,” says de la Durantaye. “But from a pure valuation perspective, [they’re] by far the most undervalued equity markets.” As profit margins peak in the U.S., he adds, they’re more likely to stabilize in emerging markets.

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