Can there be a free lunch?
We're about to find out as the fiscal and monetary spigots keep pouring.
A much stronger than expected V-shaped recovery! Q1 earnings are on track to increase at a 100% quarter-over-quarter rate! At +23%, the earnings surprise factor remains six times the long-term average (perhaps the strength of the V is not yet priced in). With 63% of all guidance classified as positive, the second quarter is setting up to be gangbusters, too. Comps remain very easy, Q2 economic growth will continue to be strong and credit conditions have never been better in the 23 years Renaissance Macro has been measuring them. The outlook for capital spending and employment is bright despite this morning’s disappointing jobs report (more below). Housing, manufacturing and services sectors have been setting new and/or multiyear highs, constrained only by struggles to find developable land, supplies and workers (more below). Flush with another round of stimulus checks (March incomes jumped the most since records started in 1946) and with household wealth as a share of income the highest in U.S. history, consumer spending soared nearly 15% in Q1 and by Evercore ISI’s count, already is up another 10% so far this quarter. Activity is accelerating overseas, too, lifting the global composite PMI to an 11-year high, as vaccines keep rolling out and more and more of the global economy reopens.
Inflation hit home this week. I was notified of price increases by my dog groomer, landscaper and bug man—and they don’t even know each other. By Bank of America’s count, mentions of “inflation” are up almost 800% year-over-year (y/y) with the majority of earnings reports in. Raw material prices keep going up, supply shortages keep cropping up and complaints of worker shortages are rampant. The NFIB’s gauge of hard-to-fill job openings is at a record high and a level associated with the end rather than the beginning of a recovery. It notes some small businesses are having to pay applicants just to show up for an interview. Manhattan restaurants are struggling to attract experienced employees. Starbucks is dealing with supply delivery bottlenecks, Chevron can’t find enough truckers and Amazon, Domino’s, Uber and Lyft are struggling to find drivers. Hiring incentives and wage hikes to woo and retain workers are everywhere—an issue that could last until September, when expanded unemployment benefits end, as unlike last summer, the biggest needs tend to be on the lower end of the wage scale. Meanwhile, unprecedented fiscal stimulus keeps coming—more than $5 trillion so far, with as much as $4 trillion more if President Biden gets everything he wants (perhaps he’ll use today’s jobs report as justification). U.S. debt-to-GDP looks to soar far above 100%, potentially challenging 1946’s 118.8% record, when all the World War II bills came due. A new paper by my bond colleague Don Ellenberger and Strategic International Securities’ Philip Miller finds whenever fiscal deficits can’t be sufficiently financed by demand for the debt, the Fed becomes the buyer of last resort, which historically has led to high levels of inflation, currency weakness and high real interest rates.
Yet real yields remain negative across most of the curve, long bond yields have retraced significantly off March highs and were down further on this morning’s big jobs miss. What does the bond market know that others don’t? Might it, like the Fed insists, believe near-term pricing pressures may indeed prove transitory and/or that moderate Dems may rain on the White House’s fiscal party? When it comes to proposed tax increases, the market and companies are acting as if they’re from Missouri: they want to see the final tax plans first. The subject hardly has come up in earnings calls. Historically, thanks to capitalism, supply pressures tend to the work themselves out. And since the late 1970s, the link between inflation and wages has been broken. There’s still massive slack in the labor market—we’re still some 8 million jobs short of our pre-pandemic peak, with participation held down by Covid fears, child-care issues and the reality many are making more just sitting at home thanks to outsized jobless benefits. Bank of America believes vaccine deployment, economic reopening, stimulus, etc., are largely priced in—it’s concerned near-term with near euphoric sentiment. There hasn’t been a 5% pullback in six months (they tend to occur three times a year) or a 10% correction in 14 months (a once per year phenomenon, historically). Maybe that’s what we’re setting up for, with Fed taper talk a potential catalyst. Consensus had thought that could come at June’s meeting, but the weak April report may put off that discussion. Joining the Royal Bank of Canada, the Bank of England this week slowed its bond buying and signaled it’s on course to end support later this year. Other central banks are sounding an end to extraordinary stimulus, too. Meanwhile, even traditionally hawkish Fed policymakers this week signaled they’re falling in line with the new regime under Powell, suggesting the Fed probably tapers last—not necessarily a good sign for the dollar. Strategas Research wonders whether concerns about future budget deficits may render the currency markets the ultimate check on monetary and fiscal policies that are so broadly aligned and accommodative. It’s a brave new world we’re living in. Can there be a free lunch? We’re going to find out.
- Closing in on normal The Markit U.S. Services PMI jumped to its highest level since data started in October 2009, with new orders climbing at their fastest rates on record. The separate ISM services reading slipped but still came in at its second-highest level on record.
- Closing in on normal Private residential construction spending jumped 23% y/y, its fastest pace since 2013, as builders rushed to meet soaring demand for homes. It hasn’t been such a great time to add office capacity, however, as the pandemic put the kibosh on new office construction, causing March non-residential spending to shrink 9% y/y.
- This should help hold the line on inflation Nonfarm productivity rebounded at a 5.4% annual rate in Q1, its biggest gain since Q4 2009 if the Q2 2020 surge after the pandemic lockdown is excluded. Output jumped at an 8.4% annual rate, the second most since Q3 2003, while hours worked picked up at a 2.9% annual rate.
- Why is this a “negative?” April’s nonfarm job growth came in at 266K, about a quarter of consensus. However, ISI says adjusted for reduced participation, labor market slack came down, and the index of aggregate hours was up by an amount commensurate with +600K. Further, wages were higher, announced job cuts crumbled to levels not seen since 2000 and weekly initial jobless claims sank to a pandemic-cycle low.
- Not bad, just not as good ISM and Markit manufacturing readings disappointed in April, as both came in below consensus. The 4-point drop in the ISM represented its biggest pullback since last year’s lockdown, with raw material and component shortages creating bottlenecks and causing short-term shutdowns. Still, the level of activity remained historically high and contributive to GDP.
- When bigger isn’t better March’s trade deficit widened to new record as a resurgent America gobbled up goods at a far greater pace than foreign customers bought U.S. products. The trade surplus in services also narrowed to its lowest level since August 2012 on continuing Covid-related travel and tourism restrictions. The net effect looks to shave nearly a point off Q1 GDP when revisions are made.
Machines don’t ask for a wage hike When minimum wages were a hot topic in 2014, Panera and other fast-food businesses automated a lot of its services. McKinsey sees this trend accelerating, with 100 million low-wage jobs globally likely to lose out to automation by 2030.
A brave new world With machines and algorithms taking over more tasks, the need for increased education and retraining to bridge the skills gap is likely to grow, suggesting an increased government role in supporting affected workers motivated enough to retrain. And that could take us ever closer to a guaranteed basic income.
The sad irony That’s how Ned Davis characterizes many of the proposed tax increases, particularly on foreign earnings, capital gains and estates, as they target those with the means to pay for investment vehicles that minimize the very taxes the government is trying to collect. The result is the burden again would again fall on the lower upper-income and middle classes.