Stocks with high labor costs are positioned to benefit as wage growth decelerates, providing a boost to profit margins, according to Goldman Sachs.
According to the bank's recent analysis, wage growth in the U.S. labor market has decelerated to 3.9%, down from a peak of 6% in August 2022, and is projected to stabilize through 2026.
This easing of wage pressures comes as the labor market rebalances, and fewer companies report labor shortages during earnings calls. Goldman notes that a "loosening labor market" is supported by both macroeconomic data and corporate commentary, with the share of S&P 500 firms discussing labor shortages now at its lowest since 2019.
The bank also highlights that labor costs currently account for 12% of total revenues for the aggregate S&P 500 index and 14% for the median stock. It estimates that a 100 basis point change in labor costs would impact S&P 500 earnings per share (EPS) by 0.7%, with some sectors more sensitive than others.
Consumer Staples, for instance, with labor costs making up 9% of revenues and relatively low EBIT margins, could see a 1.0% increase in EPS if wage growth continues to decelerate. Meanwhile, Information Technology, despite labor costs representing 18% of sales, would only experience a 0.5% EPS boost due to its higher EBIT margins of 32%.
Moreover, Goldman reflects on the recent market performance of labor cost-sensitive stocks. Their sector-neutral basket of S&P 500 stocks with the highest labor costs has outperformed its low labor cost counterpart by 70 basis points year-to-date, with the largest outperformance occurring since July.
This “suggests investors are confident that wage pressures on company earnings will continue to subside,” the note states.
"High labor cost stocks should continue to outperform low labor cost stocks as wage growth continues to decelerate," analysts at Goldman Sachs added.
It forecasts wage growth will fall to around 3% and remain steady through 2026. Downside risks in the labor market could further reduce wage pressures.
Currently, high labor cost stocks trade at only a slightly higher price-to-earnings (P/E) valuation than low labor cost stocks, and Goldman notes that valuations have not been a strong predictor of future returns.