The '70s. Good times, although...
We could do without leisure suits (maybe) and stagflation (definitely).
I love the 1970s. Best decade for music (IMO). I rocked my bell bottoms and was a UPenn disco queen. Lots of similarities between then and now. (We’re not just talking bell bottoms and velour track suits, both of which are making a comeback.) High grocery, oil and gas prices. Wage increases. Worker strikes. Money supply growth is much faster now—the Fed is effectively underwriting the CARES Act, with Fed liabilities to the Treasury jumping from near zero to $1.2 trillion—and debt levels are much higher. Also, globalization that brought price competition is slowing, working-age populations are shrinking and we’re running short of everything (housing, workers, materials, port capacity, etc.). A count of words associated with supply-side complaints in this week’s Beige Book was nearly as high as in the ’70s. Late ’70s’ Fed inflation forecasts persistently underestimated inflation and it’s the same today. PCE forecasts have been revised up in each of the past five Fed meetings that included projections. It seems the Fed’s fighting the last war, when post-financial crisis demand remained stubbornly weak, prompting ultra-accommodation. But demand isn’t the problem now. It’s supply that can’t keep up. A lot like in the ’70s. Hmm.
Still, equities love easy money, especially if it comes with economic and profit growth. Next week’s Q3 GDP report is certain to reflect a sharp slowdown, but newer data suggest Q4 reacceleration. Total card spending as measured by Bank of America jumped 19% over a 2-year period for the week ended Oct. 16, October services activity jumped (more below), September home sales surprised (more below) and jobless claims hit a post-pandemic low. As Covid cases rapidly decline, airline traffic is perking up—executives in calls this week expected a strong holiday season—and restaurant reservations are climbing. With a quarter of S&P 500 market cap having reported, earnings are beating estimates by 13%, Credit Suisse says, with 80% of companies topping projections. Current expectations put Q3 S&P revenue and earnings-per-share growth at 14% and 29%, respectively. Many companies report they’ve passed on price increases with little pushback. After sidling for months, the Value Line Index (an equally weighted composite of roughly 1,700 issues) broke out, a sign the “average stock” is getting better and the market’s not captive to just a few mega-cap growth names. Indeed, the percentage of S&P stocks at 20-day highs has jumped. And investors remain skeptical, a nice contrarian positive.
What does the bond market know that the equity market doesn’t? That perhaps this isn’t the ’70s redux? Forward inflation breakeven rates are in the middle of the range they’ve been in for the past decade, with the pure inflation expectations component hovering around the Fed’s long-term target of 2%. This suggests the market believes that current elevated inflation will prove transitory, even if transitory may be longer than some expect. The future behavior of inflation, and how the Fed is likely to respond, remains pivotal to the global investment debate. The latest CPI and PPI reports contained evidence of slackening inflation momentum, though it’s early to make a definitive call. Owners-equivalent-rent is climbing, used-car prices are rising again and wage inflation is picking up. But inflation expectations—whether those of the markets, households or economic forecasters—remain well-anchored. This doesn’t negate the concern about a potential Fed policy mistake. But Strategas Research thinks “peak bottleneck” should lead to “peak inflation” in short order. In D.C., it looks like a slimmed-down deal is going to get done (I just wouldn’t bet against Pelosi), with the spending front-loaded and taxes back-loaded. (A nod to next year’s midterm elections.) This adds to arguments for a continued bull market. The ’70s were so much fun. Fingers crossed for this decade. I mean, bell bottoms are back! Donna Summers, ever heard of her?
- Housing has momentum September existing homes sales unexpectedly jumped to an 8-month high, and the median sales price climbed, too, as the imbalance between supply and demand intensified. Separately, builder optimism blew by consensus, climbing to a 3-month high on rising buyer traffic and future sales.
- PMI points to pickup A surprise jump in services pushed Markit’s initial take on overall October activity to its fastest pace of expansion in three months. Manufacturing slowed a third straight month but remained elevated. Factories continue to be hampered by supply chain issues and shortages, factors—along with Hurricane Ida—that also saw September industrial production decline. Philly Fed October manufacturing slipped but stayed expansionary on strength in orders, employment and shipments.
- R&D is booming Over the last two quarters, research and development spending has grown at nearly an 8% annual rate, more than twice the pace over the last two decades, Renaissance Macro says. R&D is an important source of productivity growth within firms and necessary for product innovation, though it takes time to translate to the bottom line.
- Weakening Chinese demand poses downside risks globally New home prices in China fell for the first time since April 2015, and a real estate sector that accounts for roughly 30% of GDP contracted 1.6% year-over-year (y/y) in Q3. During early October’s weeklong holiday, spending fell 5% y/y and September passenger car sales plunged 25%. Overall growth is at a 3-decade low, with Q3 GDP and industrial production growth below 5% for the first time in the post-Tiananmen era save the brief Covid recession.
- Housing’s supply challenges While rising sales and builder optimism are encouraging, September’s declines in starts and permits suggest low inventories and higher prices will remain a drag on housing. Total y/y permits were unchanged and have been effectively flat since an initial post-pandemic spurt. The story was the same for starts.
- It’s the ’70s in Germany, too Producer prices there last month accelerated above 14% y/y, the fastest pace since November 1974. And a proposed minimum-wage increase would hand 4 million German workers a 25% pay raise, feeding fears of further price rises and a self-reinforcing feedback loop.
It’s hard to hike in the face of political pressure That the lesson the ’60s taught in Bank of America’s look back at the interplay between growth, inflation and the Fed over the last six decades. The “guns and butter” decade was marked by a sharply overheating economy and a White House that effectively forced policymakers to let it ride.
It’s costly to put the inflation genie back in the bottle It took a dramatic assault on inflation in the ’80s, starting with the Carter credit crunch in ’80 and the Volcker-induced recession of ’81-2, to reverse spiraling inflation. Even then, after initially falling sharply, inflation leveled at stubbornly high levels, in part because the prior decade’s experience taught people to expect high inflation.
“Rehab recoveries” are painfully slow Banks, housing and household balance sheets took years to recover from the global financial crisis. By the time they did, declining inflation expectations had offset a tight labor market’s inflationary impact, causing inflation to flirt with but never achieve the Fed’s 2% target on a sustained basis.