Follow the 'economists'
They don't see inflation tripping up the economy anytime soon.
What in the world is up with yields?? The 10-year Treasury jumped above 1.30% this week to pre-pandemic highs, and the term premium—the amount of yield investors demand above short-term risk-free rates—returned to positive territory for the first time since 2018. Interest rates are rising in tandem with the vaccination rate, the outlook for massive additional fiscal stimulus and inflation expectations (more on the latter, below). The runup in yields caused stocks to wobble (bond yields stuck near historical lows have justified elevated valuations), though as of this writing, the major indexes were rising and were near all-time highs. Not since 2009 has the MSCI All Country World Index 200-day smoothed average exhibited such strong momentum on a 21-day basis, Ned Davis says, and not since 2010 have such a high percentage of stocks been above their 200-day smoothed averages. In the U.S., the S&P 500 has advanced 74 trading days without a 5% correction and 229 days without a 10% decline, consistent with secular-bull means of 84 and 331 days, respectively. This suggests the rally could continue for another 878 days before it would reach the mean number of days without a 20% decline. While nowhere near their dot-com highs, when stocks selling 40 times or more above their forward earnings comprised 52% of the large-cap market cap versus 30% today, P/E levels are stretched. This calls to mind the 1960s, when reflation on an expansionary “guns and butter” fiscal policy led to inflationary pressures that continued until the early 1980s.
Indeed, the inflationistas were out in full force this week. Oil, electricity and commodity prices shot up as the polar vortex settled over Texas, giving the Lone Star State a big taste of Minnesota winters. Wednesday’s January PPI was a big surprise (more below), and came before the expected jump over the next three months as prices get compared with a year ago, when they actually fell on a pandemic-driven collapse in demand when the entire world shut down. Oil prices last April even briefly turned negative! Inflation is fast becoming the hottest topic in financial markets for a couple of reasons: worries about supply shortages already evident in housing and autos (more below), and on textbook concerns that say government debt runups such as what we’re undergoing now have never ended well. Inflation expectations in Deutsche Bank’s monthly survey have been rising every month since May, with the biggest jump in January after the Georgia Senate run-off gave the Biden administration a green light for its expansive fiscal agenda. But there is one important group that isn’t buying into the building inflation scenario—economists. From the Fed to Wall Street, purveyors of the dismal science continue to suggest the pronounced upward “blip” in headline and core inflation rates that almost are certain to hit in coming months likely won’t stick. In fact, in the latest Philly Fed quarterly survey of economic forecasters, the majority thought the medium-term inflation outlook would remain close to 2%.
What would keep inflation restrained? Goods prices that have been rising should pull back as supply chains reopen in a post-Covid world, offsetting a likely jump in service prices as hospitality industries from hotels to restaurants to theme parks and sports venues open their doors again. Moreover, data on capital expenditures (February saw the equipment finance industry’s monthly gauge jump to is highest level since September 2018, and a Citigroup survey said ex-energy capex should run 5% above 2019) suggest the U.S. is in the early stages of a period of robust business investment, which should push out the U.S. capacity frontier, just as occurred in the late 1990s, when the economy expanded strongly but core CPI stayed below 2%. The strong 2004-07 period saw similarly well-behaved inflation. Then there’s the most-friendly Fed. It has said it would allow inflation to run hot, i.e., above 2% (it’s not there yet) for a while to help a Covid-crushed economy heal. In minutes released this week, it again indicated it’s ready if needed to shift quantitative-easing purchases to the longer end of the yield curve to keep longer yields from dampening the nation’s risk appetite. All of this indicates inflation and interest rates aren’t likely to trip up the economy or markets anytime soon. Q1 CEO confidence nearly hit a record high and was significantly above anything in the last expansion. This was driven by expectations for a strong recovery this year that has economists nudging growth forecasts up to levels last seen in 1984. More than 60% of S&P companies saw margins improve in Q4 (!), meaning rising top-line growth should easily filter down to the bottom line. This suggests current expectations for a 4% increase in earnings over 2019’s high-water mark will prove low. Along with the first positive inflows into equities in 12 years, it remains dangerous to be bearish. We’re supposed “to follow the scientists,” aren’t we? Perhaps we should also follow the economists.
- Consumers are busy January retail sales blew past consensus, more than offsetting 2020’s end-of-year slump and lifting overall sales to a record high. With more stimulus checks likely and Bloomberg consumer optimism about the direction of the economy its highest in a year, Evercore ISI estimates first-quarter consumer spending will soar at a 7.8% annual pace, even with a possible pullback this month. With inventories to sales at a 6.5-year low, the sales jump adds to the inventory rebuild case.
- Manufacturers are busy Industrial production rose at nearly double consensus and for a fourth straight month in January, with most sub-manufacturing industries posting gains in excess of 1%. Only vehicle production slipped as the global shortage of semiconductors impeded production. Regional PMIs got off to a strong start in February, while Markit’s initial take on the month remained strong and its companion services surprisingly rose, lifting the composite reading to near a 6-year high.
- Home builders are busy The National Association of Home Builders confidence gauge edged up and continues to hover near a record high. This suggests housing starts should keep trending up despite January’s stumble on rising input prices amid tight supplies. Permits on the month shot up, pushing the annual rate to its highest since 2006, ISI’s propriety builder survey hit a new record high and January existing home sales climbed as buyers snapped any new listings.
- Here’s what got inflationistas talking January producer prices surged a record 1.3% as both goods and services prices soared. Core PPI rose 1.2%, also a record and six times the consensus forecast. On a year-over-year (y/y) basis, PPI was up 1.8%, its fastest pace in a year, while core PPI advanced 2%, the most since September 2019. Import prices also jumped the most in nine years, and export prices climbed a record 2.5%, lifting their y/y rate to 2.3%.
- The jobs recovery will determine the shape of the recovery Initial weekly jobless claims unexpectedly rose, and prior weeks were revised up sharply. While some new filings likely reflected temporary auto plant shutdowns due to the global chip shortages, jobless claims have lingered near their current level for the past couple of months, further evidence that labor-market improvement has stalled.
- Housing “have-nots” Nearly 3.6 million 90-day mortgage defaults occurred in 2020—the largest number since 2009—with 2.1 million homeowners currently seriously delinquent on their mortgage payments. Government support payments and a moratorium on mortgage foreclosures are helping to avoid a catastrophe but when forbearance plans begin to expire in March, there would still be approximately 1.5 million more serious delinquencies than at the start of the pandemic.
MMT is not supposed to be Magic Money Tree The White House’s stimulus plan would provide $350 billion to state & local governments, enough to make every state whole from any revenue loss that occurred in 2020. Local governments, which did not have declining tax revenues, would receive 17% of their revenues from the new aid. This is on top of last year’s 44% jump in pandemic-led federal support that is expected to cause state & local governments as a group to post their first budget surplus in 42 years once the final data comes in.
Regarding the minimum wage debate The main characteristics of minimum wage workers who represented a record low 1.6% of all hourly paid workers in 2019: more than 40% are younger than 25 years, and nearly 1 in 5 are teenagers; more than half have only high school education or less, partly due to the fact that they are still in school; two-thirds are women; the majority are part-time workers; most are in the South; and more than 60% work in leisure and hospitality, mostly in food preparation and serving jobs.
Dark winter? U.S. intensive care bed and ventilator utilization is now back below where they were in March and April 2020, when Covid cases were only an eighth as many as there have been in this “dark winter.”