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Keep growing and carry on

The Days Ahead: Light economic calendar so focus on earnings

One-Minute Summary We had a ton of economic data with a Fed meeting right in the middle of the week. The economic data was generally good.


Productivity numbers

Employment costs


 Not so good

Personal consumption

ISM manufacturing

ISM Services


Stocks finished April with a fourth consecutive month of growth. That doesn’t happen often. The S&P 500 and the S&P 600 (small cap) are both up 17% this year. Tech has led again, up 27%. Last week, Apple beat and Google missed. But Apple, Facebook, Microsoft, Amazon and Google, are up between 15% and 50%. They're the five largest companies in the world and around 13% of the index. That’s a heck of a good run.

1.     What did the Fed say? That they’re going to stay patient, that inflation was too low but that most of it was transitory (see below). The market expected most of what was said so there were no big market moves.

The Fed finds itself in an interesting position. Employment is going gangbusters, Q1 growth was fine but inflation remains well below target. For now, the inflation number rules and they’re going to keep watching and doing nothing.

Richard Clarida, a very fine Governor, made a speech on Friday, which emphasized the market and pragmatic approach to inflation, rather than a model based approach, and concluded “the federal funds rate is now in the range of estimates of its longer-run neutral level.” Which seems right. So don't expect a cut this year unless something very bad happens.

And this is good. Steve Moore: “My biggest ally is the president. He’s full speed ahead.” Ninety minutes later, he withdrew the nomination.  

2.     Why is inflation so low? Is a question the Fed keeps asking and comes up with “it’s transitory”. But is it? Despite many years of warnings that inflation was just around the corner (the Fed’s QE bought out a lot of the crazies on this)…well, it’s not.

It’s probably the most important question for markets right now. If inflation rises, bond yields will rise to compensate investors for a lower real rate of return. Same for stocks. Equities are a great inflation hedge because, in theory, they can raise prices. But their costs rise as well and investors need higher returns to compensate for the loss of purchasing power. Inflation was the bane of the 1970s. Eventually, we saw Treasury yields at 16% and stocks trading at 8x earnings and yields of 8%.

Since then, however, inflation has steadily declined. Here’s the headline CPI and the Fed’s preferred PCE inflation, showing the broad number and the “core” numbers, which exclude food and energy.

Inflation had barely broken 2% for decades

The latest numbers show 1.5% for the PCE and 2% for the CPI, with the former well below the Fed’s 2% target.

The two measures of inflation differ quite a bit. Here’s a full explanation but basically the CPI measures out-of-pocket expenses and the PCE measures those and other expenses which people pay for indirectly, like medical insurance. Housing is very big in the CPI at 42% but only 23% in the PCE. Medical costs are only 8% in the CPI but 22% in the PCE.  

Anyway, here are some of the reasons why inflation is so low:

  1. Strong dollar: decreases import costs

  2. Lower medical inflation: yes surprisingly but you won't know it because deductibles are through the roof

  3. Services: transportation (all those subsidized Uber rides), professional and personal services are all lower mainly because unit labor costs are down

  4. Substitution: it’s a lot easier to substitute products these days, so if TV prices are down 20%, people may just buy a tablet and hook it up to a screen. The same goes for foods. Lettuce fans (prices up 18%) can switch to lentils (down 5%). No comments, please, on our food choices.

  5. Productivity: showed a recent climb, which allows companies to reduce price without a margin hit

  6. Underreporting: there’s probably a downward bias in inflation reporting because of things like hedonic adjustments. This tries to adjust for things that cost more but are a heck of a lot better than a few years ago. Compare your car or computer now to a decade ago and chances are they’re about the same price but do a lot more.

    These adjustments are fiendishly difficult and I don't envy the pros at BLS but the sum effect, we think, is to understate costs.

 Will it continue? Yes probably. If the above chart is anything to go by, apart from momentary blips, inflation has anchored at 2% for the best part of three decades.

3.     Jobs numbers blow out. Well not quite but very good. You’ll have read about the best numbers since 1969 etc. and we’re not about to take the shine off the numbers.

What, wait, of course we are! First, we’ll not restate points about lower labor force participation, which fell again, or the low increase in Average Hourly Earnings, or the still high underemployment rate. No, not going to.

 Instead, we’ll point to lower average hours worked and a fourth straight month decline in the labor force. This time it fell 500,000. This doesn't take away from the fact that the numbers were strong but we’re not sure it means things like wage pressure or that these sorts of gains can continue.

Here’s the chart:

Nice recovery in new jobs

Treasuries rallied on the news. Normally (what’s that these days, I know) a report like this would mean a Fed ≠hike, inflation corner and blooming consumer confidence. But the Fed has said it’s on pause so it means that the curve steepened a bit (i.e. good for short Treasuries like FRNs).

Bottom Line: Earnings season continues. We've seen mostly positive comments from companies about the U.S. and with continuing caution on trade/China/Brexit/Europe. We expect that to continue.

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