Will “Missing Workers” Start to Weigh on U.S. Stocks?

America’s labor-market dynamics increasingly confound employers, policymakers and investors alike. Take last week’s job openings and labor turnover report from the Department of Labor. A record 4.3 million workers quit their jobs in August, while the number of job openings—down slightly from its July record—stayed stubbornly high at 10.4 million, even as some five million workers remain unaccounted for, compared with pre-pandemic levels. 

The shortfall has left many businesses scrambling—and many experts asking: Where are the workers and why aren’t they working?

Financial market bulls may see these conditions as temporary, related to lingering concerns around pandemic risks, resistance to workplace vaccine mandates or the overhang of expiring extended unemployment benefits.

Yet, as we mentioned back in June, we think that these developments represent a labor market undergoing structural changes that could affect inflation, supply-chain disruptions, the pace of monetary-policy tightening and stock-market performance.

More immediately, today’s labor shortage has chilled business sentiment, sending the U.S. National Federation of Independent Business’s index of small-business optimism to 99.1 in September, the lowest since March. Among surveyed business owners, 51% reported job openings they couldn’t fill, a third-consecutive monthly record. An unprecedented 42% of companies said they have raised compensation, and 30% plan to raise pay over the next three months. And, you guessed it, that’s a record, too. 

Why this scarcity of workers? First, consider how the workforce has contracted during the pandemic. At least 200,000 among the more than 750,000 COVID-related deaths in the U.S. belonged to the eligible working population, according to Centers for Disease Control and Prevention estimates. Meanwhile, another part of the population may be experiencing “long COVID” symptoms that keep them from full-time work.

We must also factor in accelerated retirements. Analysis by Morgan Stanley & Co. Chief U.S. Economist Ellen Zentner shows that about two million more people exited the workforce due to retirement than demographic trends would have predicted.

Workers themselves have adjusted to many changing attitudes and behaviors around work that have given them more leverage. In particular, “white collar” employees who were able to work remotely during the pandemic now realize they can work from anywhere. Meanwhile, “frontline” workers who faced elevated stress and health risks throughout the pandemic, often in poor working conditions, now demand better wages and benefits. 

Then come the so-called nonessential sectors. This category, which  broadly covers recreational and service businesses, faces a particularly acute labor shortage, as its workers switch careers, fueling a surge of retraining and career repositioning, enabled by online learning and professional certification options, as well as a push toward the gig economy and entrepreneurship.

All of these factors suggest a metamorphosis of the U.S. labor market that will push up wages—as evidenced in the small-business data—which in turn could further fuel inflation.

This is important not only for monetary policy, but also for company bottom lines and stock markets. Labor costs comprise a significant portion of corporate balance sheets—more than 54% of S&P 500 companies’ expenses, or as much as three to four times other line items.

This strikes at the heart of many investors’ bullish view toward equities, based on the belief that strong earnings growth will continue to power returns. Investors in such sectors as financials seem to have factored in the potential for higher wages to pressure profit margins and restrain earnings growth momentum, but investors in technology still seem overly optimistic.

In this environment, investors should watch wage-growth and inflation metrics, and consider balancing active stock selections between capital-intensive and labor-intensive businesses. We favor overweighting financials and energy vs. consumer staples and healthcare, while underweighting consumer discretionary and technology, which continue to look expensive.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Oct 18, 2021, “The Great Resignation.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.