Why low unit labor costs matter now: Insights from Denise Chisholm - January 15, 2026

Current inflation trends and unit labour costs

Inflation continues to ease in an environment shaped heavily by unit labour costs. These costs, a productivity adjusted measure of wages, are sitting in the bottom quartile of their historical range and are currently growing at roughly 1.2 percent. That level is unusually low when unemployment remains tight. Rising productivity is also helping companies generate more output for every labour dollar spent. Together, these trends have historically lined up with lower inflation and help explain why core CPI for December came in at 2.6 percent. When labour costs rise this slowly, it becomes harder for temporary price increases to take hold, which supports the broader cooling pattern seen across the economy.

Understanding the earnings backdrop in today’s environment

Earnings strength remains a central feature of this cycle. Low unit labour costs have historically been linked with stronger profit margins and the recent data points to conditions that have supported margins in the past. Productivity gains are playing a key role by enabling companies to operate more efficiently without significant additions to payrolls. Real interest rates have also shifted into the lower half of their historical range, a level that has often supported earnings growth in the past. Together with the ongoing capital expenditure cycle, these trends point to conditions that have supported earnings in the past. Despite three consecutive years of market gains heading into 2026, the backdrop still points to durable earnings rather than a late cycle slowdown.

What the data suggests for Federal Reserve policy

Policy direction from the Federal Reserve is best interpreted through the data. Some public debate has suggested that policy rates could move toward 1 percent, although such a level could create challenges for the economy. A more realistic path involves gradual renormalization as inflation continues to ease. The final pace of any cuts, whether 25, 50 or even 75 basis points, will depend on incoming data. Internal debate at the Fed should not be viewed as a sign of instability. Instead, it reflects the reality that monetary policy is not straightforward in the current environment. With inflation easing and productivity improving, the Fed has room and could adjust policy without disrupting broader economic conditions.

A full employment recovery with moderate steady growth

Today’s economy reflects a recovery that has taken place under full employment conditions. Payroll growth has been very slow, at times hovering near zero, yet productivity and revenues have continued to move higher. GDP growth sits just above 2 percent year over year and median earnings growth falls in the 10 to 12 percent range. This creates a modest but steady expansion that avoids the excesses seen in stronger cycles. While affordability pressures remain for many households, particularly in areas like housing, history shows that the most durable improvements occur when wages rise slightly faster than inflation over long periods. Rapid drops in prices, on the other hand, tend to accompany recessions. The slower path that the economy is on today can feel uncomfortable but also supports a more stable foundation for markets.

Analyzing the AI narrative: bubble fears versus real profitability

The rise of artificial intelligence has sparked discussion about whether parts of the market resemble a bubble. Denise discussed how recent performance patterns don’t line up with what is typically seen in bubble environments. Five of the seven Mag7 stocks underperformed the market last year, which contradicts what normally happens during speculative periods. Many technology companies are also reporting rising operating margins despite increasing investment in data infrastructure and capital equipment. These signals point toward real productivity improvements rather than unsustainable excess. Conversations about bubbles need to be precise because the broader data does not line up with previous examples of market overextension.

Valuation support makes financials worth watching

Financials stand out due to significant valuation support. The sector began the year at a bottom decile forward price to earnings ratio, a level that has historically been followed by outperformance roughly 70 percent of the time. The average relative gain in similar past periods has been around 500 basis points. Early bank earnings often paint an inconsistent picture since results tend to be idiosyncratic. A more complete view emerges once the full earnings season unfolds. Even so, valuation trends provide a strong foundation for the sector as 2026 progresses.

Top and bottom sectors

Denise expects a broader market participation this year rather than a rotation out of technology. The data points toward maintaining core technology exposure while widening allocations across complementary areas.

Top sectors

1. Financials with particular strength in capital markets and brokerage firms
2. Technology led by semiconductors
3. Consumer discretionary driven by home builders and other rate sensitive segments

Bottom sectors

1. Consumer staples which appear fundamentally challenged and may resemble a value trap
2. Utilities which remain too expensive relative to their returns and are not an efficient way to gain AI exposure at the sector level
3. Energy which continues to face excess supply that weighs on oil prices and sector level fundamentals

Conclusion: Navigating a stable and data driven market environment