West of the Hudson

Dear Clients:

Our recent monthly and quarterly communiqué have focused on the broad narrative that a brisk U.S. economic re-opening is driving inflation inexorably higher. Savings rates are elevated, credit is widely available, interest rates are ultra-low, and there is pent-up demand in services from the Covid-induced recession. But the recovery has not been linear and is advancing in fits and starts. For example, sales of physical goods dipped briefly when Covid hit, recovered quickly, and are now well above their prepandemic levels. In stark contrast, businesses that deliver personal services, such as hospitality and leisure, suffered a devastating depression and remain well-below pre-pandemic levels. As we make the transition from goods to services consumption, we are optimistic, but our visibility is obscured by erratic data, including the most scrutinized post-pandemic data series: employment.

The past quarter was notable for how quickly the hyper-inflation narrative ran into its first obstacle — another narrative, which asks, “Are there enough workers to actually sustain faster economic growth?” The U.S. labor market is entering one of its strangest periods ever, with a powerful economic rebound generating record demand for workers. Yet millions of Americans remain reluctant, or unable, to absorb the unprecedented number of job openings available, and employers across diverse industries complain that they can’t find enough workers to meet the renewed demand. There are 9.3 million unemployed, 3.6 million more unemployed than there were in pre-pandemic February 2020. It seems incongruous that business managers complain of a worker shortage. The question that first needs addressing is, with so many millions idled, “Why can’t companies find help?”

There is a loud chorus heard on quarterly corporate earnings calls, in business surveys, and from television politicians, that blame stimulus checks and ‘enhanced’ unemployment benefits for hampering hiring efforts. With so many unemployed, they wonder why they can’t find one on the cheap, as they have in the past. The narrative is easily digestible, and states simply that millions of people don’t want to work because the government provides too much unemployment insurance. There isn’t much data to support such a sweeping indictment — there are always individuals who will ‘game the system’ — so the allegation that pandemic-era benefits are discouraging employment on this scale is inadequate.

Economic recoveries are historically a time of celebration for investors, and the recovery now underway is been no different: the economy is accelerating; business activity is rebounding; and stocks and many other assets continue to surge. This is a textbook recipe for an economic boom led by the services sector, but for now, the shortage of skilled or hourly workers threatens to restrain what is otherwise shaping up to be a robust post-pandemic recovery. Many businesses — especially small businesses — have had to forgo new opportunities, decrease production, or keep sections of their establishments closed. This is partly reflected in the slow growth of income where, excluding government transfers, personal income growth was flat in an otherwise red-hot first quarter. So, while the supply/demand dynamic grinds towards equilibrium — and whose fragility is of great interest to all — there is also a law of unintended consequences, which grows exponentially alongside large-scale government programs. And the extraordinary, pandemic-driven unemployment benefits come with an expiatory date, so how the next few months develop — with Covid variants, vaccination rates, and capacity of services — is critical. As noted in our prior letter, inflation, interest rate worries have replaced Covid as the primary market risk and, while those themes are ongoing, the discourse this past quarter was dominated by the key trends that feed those themes: job openings, wages, and the unemployed. So, it is here that we jump off for this, our second letter West of the Hudson TM in 2021.

Help Wanted

We have conflicting narratives on the U.S. jobs situation: official data says millions are unemployed and seeking work, while businesses simultaneously say they can’t find enough workers. While this mismatch exists across industries, the majority of today’s labor shortage is concentrated in service jobs with high levels of immigrants. It is germane to recall that the pandemic exacerbated a trend well under way prior to Covid, where shortages of skilled workers in manufacturing, residential construction, and agriculture — casualties of the war on migrant and immigrant employees — was well underway, and is far worse today. The pandemic forced dozens of retailers into bankruptcy, liquidating thousands of stores, and terminating millions of jobs as nonessential, discretionary services collapsed. The implosion in leisure, hospitality, and transportation businesses swelled these ranks to unimaginable levels. Now, as consumers re-engage, these service jobs carry new responsibilities and higher health risks (like flight attendants and mask enforcement). They are not viewed as “the same” jobs as before, and fewer workers are immediately chasing them, especially at the same wages or hours as before.

The chronic problem we face is that, pre-pandemic, the U.S. economy was overly dependent on an abundance of part-time, “gig economy” jobs. This yielded low prices for consumers, and low labor costs for employers, but spectacularly low incomes for tens of millions of others. Meanwhile, a rollicking partisan dispute charges that federal assistance has “incentivized people to stay out of the work force”. Two dozen states have halted supplemental benefits on the presumption that a termination will unleash a flood of job seekers, but they have thus far yielded disappointing results. Treasury Secretary Yellen notes that if unemployment bonuses were impacting hiring, we would expect lower job growth in states where benefits are particularly high but, in fact, this is not the case. The Department of Labor similarly reports no uptick in online job searches in states that have begun to abandon benefits.

Busines-friendly politicians aren’t moved by a lack of supporting data, only by the macroeconomic upside to millions of workers returning to work. Many interests also stand against a (reasonable) proposal to address inequitable wages and increasing the hourly federal minimum wage from $7.25 to $15. It is admirable and past time, but surprisingly, Bureau of Labor Statistics (BLS) data reveals that just 3.5% of the workforce actually earns the minimum wage. According to the Federal Reserve, through May, the average hourly earnings in the lowest-paid sector, leisure/hospitality, is $18; it’s $22 in retail; $27 in transportation services; and $29 in education and health. Depending on where you live and how many hours you work, these wages are not as much as they seem, and $15 shouldn’t seem so threatening. According to additional BLS data, the bulk of private sector jobs eliminated during the pandemic that have yet to come back are designated as “nonsupervisory” jobs. There are 45 million total nonsupervisory jobs, of which 43% are classified as “low-quality”. This is not an inconsequential corner of the labor market and raises a fundamental question of what a healthy labor market looks like. Does it mean workers are on such a knife edge that they feel compelled to take the first job that comes along? Or is it one in which employers have to scramble, feel pressured to raise wages, and improve working conditions? Are the economy and the public better off when workers get to be choosy, or only when employers do? One observation that receives scant analysis is the role that the geographic reshuffling away from major population centers plays. New York City, for example, hasn’t fully rerecovered and carries a high level of the idled and unemployed. Meanwhile the supply of labor is constrained in the booming suburbs of NYC because most city-dwellers commute by bus/subway, don’t own a car, and are cut off from the demand. We have seen and heard of numerous anecdotes along these lines: the equilibrium between jobs and the unemployed is out of whack. It took time, years often, to find that local, pre-pandemic stasis, so it should be expected to take time again to find its balance again.

Taken together, why businesses are having such trouble hiring when so many remain unemployed is a puzzle with many pieces and, while it has generated lots of speculation, there is little hard evidence. We remain skeptical that jobless benefits alone have played an outsize role in the hiring squeeze, especially as issues around childcare and continuing health fears are well-documented contributors. In reality, this labor shortage predated the pandemic and will probably outlast it, too. Bigger forces are at work.

Wages & Skills

We are often told that wages are “falling behind”, as if pay levels are some kind of natural phenomenon instead of a management choice. Indeed, the question, “Why are job openings so hard to fill?”, leaves out a key aspect of employment. The real question is, “Why are job openings so hard to fill at these wages”? There is a simple solution to the problem of businesses not being able to find enough workers which is to raise wages or provide other forms of remuneration, such as more flexibility, paid leave or other benefits valued by employees. Indeed, one of the beauties of capitalism is its mechanism for dealing with shortages. In a communist system, consumers must wait in line when there is more demand than supply – the very definition of a shortage! A capitalist system provides a ready solution where the entity providing the item raises its prices, causing other providers to see an opportunity for profit and enter the market, thereby increasing supply. One of the few ways to have a true labor shortage in a capitalist economy is for workers to be demanding wages so high that businesses cannot stay afloat if meeting those demands, but there is a lot of evidence to suggest that the economy does not suffer from that problem today. If anything, wages today are historically low, slowing for decades for every income group (other than the affluent) so that, as a share of GDP, worker compensation hasn’t been this low since the early 1950s. The main culprits for this are corporate consolidation and shrinking labor unions (the share of union members has dropped by half since 1984, when nearly 25% of the labor force belonged to a union). These trends have given employers more workplace power…and employees less of it. Companies could raise pay if they really wanted workers back quickly, but many unfilled jobs underscore the fact that employers still aren’t ready or able to pay adequate wages, giving workers enough hours, or protecting their health. That so many are complaining about the situation is not a sign that something is wrong with the American worker, but that corporations have grown so accustomed to a low-wage economy that many believe anything else is unnatural.

The largest national fast-food franchises are acting as good corporate citizens and making a concerted effort, offering aggressive incentives to get candidates in the door. Some have increased average pay to $15/hour and are offering career advancement opportunities to manager positions; others are offering $100 to as much as a $500 signing bonuses, referral bonuses, and same day pay; while still others are offering benefits including healthcare, flexible schedules and paid time off. The most aggressive (that we are aware) offers candidates $1,000 bonuses, with the option to be paid in bitcoin. The desperation for workers means many food-service outfits have to loosen their hiring standards and put up with sub-par workers to keep the lights on, but that can be managed with time.

More problematic is the deterioration in sell-sets (the skills required for available jobs) which has become its own disruptive force. Low-skilled workers have been under intense pressure from powerful forces — globalization, demographic shifts, digitization, urbanization, and virtual forms of employment. These forces are changing how, where, and when people work, and demands continuous retraining. So, it is not at all surprising that as economic activity accelerates, efforts to hire are also being frustrated by a mismatch in skills. Economists describe this phenomenon as “reallocation friction”, the idea that the types of jobs in the economy are changing and workers are taking a while to figure out what skills they need for different roles. The market for labor has changed and it has become more difficult to refill certain roles; after all, you can’t train a one-time bike courier to become an IT specialist overnight. Ultimately, the measure of a healthy economy isn’t the availability of a limitless supply of restaurant workers willing to work for $2.25/hour (plus tips). In a market based economy, if you need to hire but are unsuccessful, you must increase wages; if you want to hire but cannot increase wages, you must offer a compelling workplace and benefits, or prepare for unfilled positions and higher than normal turnover.

Similarly, employers who ask workers to take more risk have to pay higher wages. That’s how markets work, and investors understand this — if you must take extra risk you expect to get paid for it.

Quits Rate

Remarkably, while the crisis of too few blue-collar workers is front and center, less publicly but perfectly reflective of an economically bifurcated society, more white-collar workers are quitting their jobs than at any time since the 1990s, signaling confidence among many professionals that they can gravitate to a job more suited to their skills, interests, and personal lives. This wave of resignations marks a sharp turn from the darkest days of the pandemic (twelve months ago!) when workers craved job security, while weathering a national health and economic crisis.

Even here, several factors are driving job turnover, but at its root, employees want more control over their life, hours, and work. Many people are spurning a return to business as usual, preferring the flexibility of remote work or are reluctant to be in an office before the virus is vanquished. Others are burned out from extra pandemic workloads and stress, while some are looking for higher pay to make up for a spouse’s job loss or used the past year to reconsider their career path and shift gears. It has become clear in this cohort that employers aren’t only struggling to hire new workers; they look as if they are having a hard time hanging onto the workers they already have.

A record four million Americans quit their job in April — the most since the BLS started keeping these records (2000). Across industries evidence suggests that people like the ability to work from home at least occasionally. A recent poll conducted by a large insurance agency found that 87% of those who worked from home during the pandemic wanted to be able to continue doing so after restrictions ease. According to the same survey, 42% of remote workers said they would search for a new job if they were asked to return to the office full time. Only one in five American employees say they would seldom or never want to work from home

The past year has fundamentally changed the economy and what many Americans want in their working life. This big reassessment — for companies and workers — is going to take time to sort out and it could continue to develop in surprising ways.


Let us leave you with one startling statistic: the official unemployment count is 9.3 million (through May), but there is a total of 16 million who are receiving at least one government benefit (<10% of the workforce). We have nearly twice the number of people receiving an unemployment check than the actual official number of unemployed. It does not make any sense, but it seems symptomatic of this bizarre chapter in the history of U.S. economics.

The available data confirms that we do not suffer from a shortage of labor, but rather, from idle labor that has been constrained for a variety of reasons. So, the answer to the question we posed at the start (are there enough workers to actually sustain faster economic growth) can be answered in the affirmative. The labor market’s deeper problem is the proliferation of low-paid jobs with few prospects for advancement and too little income to cover essential expenses like housing, food, and health care. The pandemic focused attention on many of these low-wage workers, who deliver food and consumer purchases, clean hospital rooms, operate cash registers, and unpack food pallets. The pandemic put their lives at risk, and we began to wonder if we are adequately remunerating a lot of the core labor we need to function as an economy and society.

Employers are not competing against unemployment insurance; but rather they are competing against each other for a valuable resource (talent) and must be ready to invest in their businesses accordingly.

And they are, as the trends developing prior to the pandemic gained speed during the pandemic. Companies are reassessing headcount and capacity, cutting in visible ways and making it known that certain jobs won’t come back as before.

While not a certainty, it certainly feels like the Monday to Friday, nine to five routine is in danger. This is another ‘new normal’ managers will have to learn and adapt to as well. Technology has become even bigger in our lives, and while there will be a bit of a reset, there is no going back. Here too, some of the changes are accelerations of trends that were well established long before the pandemic began: paperless, in the cloud, screen shares, and video conferencing. The pre-pandemic, anti-remote-work mindset is gone, replaced by a range of attitudes that vary by industry. At one extreme, some companies now expect all workers to be back at their desks. At the other, certain firms are doing away with offices altogether. Most businesses seem to fall somewhere in the middle.

There is a great reassessment going on in the economy, and it’s happening on a lot of different levels. At the most basic level, people are still hesitant to return to work until they are fully vaccinated, and their children are back in school and day care full time. There is also growing evidence — both anecdotal and in surveys — that people want to do something different with their lives than they did before the pandemic. Many employers, particularly in the service industries, grew accustomed over the years to having abundant low-wage labor. Having to compete for workers is new to them. Change is hard.

Like most asset holders, equity investors have done very well out of the pandemic, and the markets continue to hit new highs. Many of the challenges highlighted in this and prior communiqué continue to be discounted by analysts — an outlook that has sustenance so long as the yield curve doesn’t force a Fed policy response. With the changing backdrop, the market crash of one year ago should serve as a reminder that the gloss can come off without warning and it always wise to protect one’s downside. As it relates to this letter, there has been a paradigm shift in the labor market — how do we adapt to these known-unknowns? We do not time the market. Our strategy, our mantra, has long been ‘participation with protection’, attributes of which played a role during 2020’s correction. Given the ‘known-unknowns’ — current market levels (profit margins, price/cashflow, leverage), and business uncertainty (political, geopolitical, policy, and now, affordable labor availability) — our approach to portfolio construction is as relevant than ever. We don’t make predictions, but we do prepare for scenarios, including if and how this period in labor supply is transitory or impacts business at more than the margins.

There is no formulaic response to this. The fact is every business has some form of exposure to labor and the degree of challenges will be distinct for each. Many business will adapt, but not all will thrive. These outcomes depend on numerous variables, including how asset-heavy they are. We are always happy to discuss. In the meantime, Covid still persists and we remain vigilant, but as we emerge and embrace our friends and family, we wish you all peace and good health in these summertime months.

Yours truly,
Hirschel B. Abelson
Chairman , LCES
Adam S. Abelson
Chief Investment Officer, LCES

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