Dr. Ed’s Blog has moved to LinkedIn.

Fast & Furious Business Cycle

The current business cycle has been unprecedented. It has been fast and furious so far. Last year’s recession was among the worst in US history, but it lasted just two months. The V-shaped recovery in real GDP has been one of the fastest on record, with real GDP likely to surpass its previous Q4-2019 record high during the current quarter. That means that the full recovery in real GDP lasted five quarters, with the economy now in the expansion phase of the business cycle.

Not surprisingly, this remarkable performance has been reflected in the unprecedented V-shaped recovery in corporate earnings, also to record highs, in recent months. That's propelled stock prices to record highs so far this year.

Meanwhile, policymakers continue to step on their growth accelerators, hoping that inflation and financial stability remain under control. Monetary policymakers are still purchasing $120 billion per month in fixed-income securities. Some of them are starting to talk about talking about tapering these purchases. Tapering may be months away, and hiking the federal funds rate won't start until at least a few months after tapering is done. The Biden administration is pushing for more spending that will result in trillion dollar annual deficits in coming years even if taxes are raised to cover some of the spending.

Here are some of the most recent fast and furious consequences of all the high-octane fuel provided by the policymakers:

(1) Prices-paid and prices-received indexes. The prices-paid index included in May’s national survey of manufacturing purchasing managers (M-PMI) remained near April’s reading, which was the highest since July 2008 (Fig. 1). That’s not a surprise since the average of the May prices-paid indexes reported in the regional business surveys conducted by five Federal Reserve Banks jumped to the highest reading on record (Fig. 2). The average of the five regional prices-received indexes also jumped to a record high in May. All 10 regional prices-paid and prices-received indexes are at or near record highs (Fig. 3). (The data for the regional surveys start in 2005.)

(2) Backlogs for the record books. May’s national M-PMI survey showed that supplier deliveries and backlog of orders rose to record highs last month (Fig. 4). In addition, the customer inventories index fell to another record low (Fig. 5). The average of the five regional indexes for either unfilled orders or delivery times rose to a record high in May (Fig. 6).

(3) Capital spending. The good news is that the inflationary economic boom is great for corporate profits, which is great for capital spending. The y/y growth rate in weekly S&P 500 forward earnings is an excellent coincident indicator of the y/y growth rate in nondefense capital goods orders excluding aircraft (Fig. 7). Sure enough, the latter measure of capital spending on equipment and machinery jumped 0.9% m/m and 22.0% y/y to a fresh record high during April (Fig. 8).

(4) Bottom line. What the economy is experiencing may simply be a business cycle set to “fast forward” by the insanely stimulative combination of fiscal and monetary policies. We had a terrible recession last year that lasted only two months. Twelve months later, the economy had fully recovered, based on most macroeconomic indicators. Booms usually occur at the tail ends of expansions. This time, one started during the tail end of the recovery and continues at the beginning of the expansion.

That’s all great until it isn’t—because, as we all know, booms are followed by bananas. Economist Alfred Kahn, an economic adviser to former President Jimmy Carter, warned lawmakers in the ’70s that if they didn’t get inflation under control, the nation was heading for a recession or a depression. To avoid scaring the public during his testimony at the Capitol, instead of saying “recession” or “depression,” he simply said “banana.”

Lots of Liquidity

While the debate rages on over whether inflation is transitory or long lasting, there’s no debating that an enormous amount of liquid assets has piled up since the start of the pandemic.

The accumulation began with a mad dash for cash by panicked individuals and businesses. But since “Modern Monetary Theory Week” (March 23-27, 2020), when the Fed and the Treasury (a.k.a. “T-Fed”) joined forces, the huge accumulation of liquid assets has been mostly attributable to “helicopter money.” Actually, “helicopters” don’t do the situation justice: It’s been more like T-Fed loaded up B-52 bombers with cash and has been carpet bombing the economy and financial system since then. How much cash has been dropped from the B-52s, so far? Let’s count it up:

(1) T-Fed’s B-52 money. Since February 2020, the Fed’s balance sheet has increased $3.6 trillion to a record $7.7 trillion through April (Fig. 1). Over that same period, the Fed’s holdings of Treasuries increased $2.5 trillion (Fig. 2). So the Fed purchased 54% of the $4.6 trillion increase in the Treasury’s publicly held debt from February of last year through April 2021 (Fig. 3). The Fed now holds a record 25.7% of the Treasury’s outstanding publicly held debt (Fig. 4).

Just as significant, the 12-month sum of federal government’s outlays increased $2.1 trillion y/y to a record $7.3 trillion during April (Fig. 5). This extraordinary jump was led by a $1.2 trillion increase in federal outlays on income security, which includes the Economic Impact Payments, i.e., the three rounds of checks sent to most Americans since the start of the pandemic (Fig. 6).

(2) M2 & velocity. Total deposits at all commercial banks in the US rose a whopping $3.5 trillion from the March 18, 2020 week through the May 12 week of this year to a record $17.1 trillion (Fig. 7). The monetary aggregate, M2, is up $4.6 trillion since February 2020 through April to a record $20.1 trillion.

Many economists track M2 velocity, which is the ratio of nominal GDP to M2. It remains near the record lows of the past year. We prefer to track the inverse of this ratio. It shows that over the past year, M2 has been equivalent to 89% of nominal GDP, a record high (Fig. 8). The potential for all this money to fuel higher consumer price and/or asset inflation is hard to ignore.

(3) Who is liquid? Then again, it’s possible that the pandemic spooked lots of people, who’ve decided to hold more precautionary balances in liquid assets as a result.

The Fed’s Distributional Financial Accounts shows that liquid assets held by households jumped by $3.3 trillion from Q4-2019 through Q4-2020 to a record $15.9 trillion (Fig. 9). This category is the sum of currency, checkable deposits, other deposits, and money market mutual funds. Over this same period, here are the increases and latest levels of liquid assets held by the bottom 50% wealth percentile group ($154 billion to $549 billion), the 50%-90% group ($0.9 trillion to $5.0 trillion), the 90%-99% group ($1.2 trillion to $6.0 trillion), and the top 1% group ($1.1 trillion to $4.4 trillion) (Fig. 10).The bottom half of households in terms of wealth undoubtedly needed to spend the cash they received from the government for pandemic relief, so they didn’t accumulate much in liquid assets. The top half might actually have raised some cash at the start of the pandemic by selling other assets. Much of the cash they received from the government was probably saved.

The question is: What will these households do with all that cash they've accumulated since last year? Odds are they will continue to spend it on goods and services and to invest in financial assets.

Reagan & Volcker Killed Inflation. Will Biden & Powell Bring It Back From the Dead?

President Joseph Robinette Biden Jr. (JRB) aspires to be as transformative a president as was FDR in expanding the scope and scale of the US social welfare state. Biden is also the anti-Reagan president. He loves Big Government as much as President Ronald Reagan hated it. Furthermore, he has as much faith in Big Unions as Reagan distrusted them.

The Reagan Revolution didn’t last very long. President Ronald Reagan was a proponent of free-market capitalism. He was against big government. He championed the constitutional system of federalism and the republican system of checks and balances. Yet here we are three decades later with lots more crony capitalism and with the federal government bigger and more powerful than ever.

Conservative presidents have had very little lasting impact on the course of our nation. Progressive ones have made much more progress at leaving their marks. The legacies of Theodore Roosevelt, Woodrow Wilson, Franklin Delano Roosevelt, Lyndon Baines Johnson, Bill Clinton, and Barack Obama have radically changed our country. They all expanded the social welfare state to varying degrees. Now President Joe Biden intends to build on their legacies.

To some extent, the Reagan legacy was briefly revived by President Donald Trump. But now under Biden, the progressive agenda is back on the fast track. What is different this time is that Biden, unlike his progressive predecessors, seems to have no concerns about the deficits that will result from his mammoth spending programs. Sure, he is pushing to raise tax revenues to cover some of the costs of his spending plans. But revenues are very unlikely to come close to covering Biden’s ambitious expansion of the social welfare state.

Furthermore, Biden and his economic advisers seem to have no concerns about the inflationary consequences of their policies. On the contrary, they are pushing for higher wages and more power for labor unions. Their regulatory policies, especially the ones aimed at climate change, are going to add lots to the cost of doing business. Their plan to raise the corporate tax rate will do the same. Yet just last week, Treasury Secretary Janet Yellen said, “I don’t think there’s going to be an inflationary problem, but if there is the Fed can be counted on to address it.”

Reagan may not have been as transformative as other presidents, but he helped to end the Great Inflation of the 1970s by supporting Fed Chair Paul Volcker's tough monetary policies. He also accelerated the demise of the labor union movement in the private sector when on August 5, 1981 he fired more than 11,000 air traffic controllers who had ignored his order to return to work after their union, the Professional Air Traffic Controllers Organization (PATCO), had organized an illegal strike. That marked the end of the wage-price spiral of the 1970s, as many private-sector business executives, following in Reagan’s path, successfully pushed back against their labor unions.

Biden loves labor unions and intends to do whatever he can to bring them back in the private sector. He is also pushing to raise wages. Consider the following:

(1) Raising wages at federal contractors. On April 27, Biden signed an executive order that requires federal contractors to pay a $15-an-hour minimum wage. Currently, the minimum wage for federal workers is $10.95 per hour, and the tipped minimum wage is $7.65 per hour. According to The White House Fact Sheet, starting on January 30, 2022, all government agencies will need to incorporate a $15 minimum wage requirement into new contract solicitations, and by March 30, 2022 all agencies will need to implement the minimum wage into new contracts. Additionally, government agencies will need to implement the higher wage into existing contracts when contracts are extended each year.

(2) Promoting unions. On April 26, Biden signed an executive order that will create a task force to promote labor organizing at a time when just over 6% of US private-sector workers belongs to unions (Fig. 1). The White House task force will be headed by Vice President Kamala Harris with Labor Secretary Marty Walsh serving as vice chair. The order is in the tradition of the National Labor Relations Act, which was passed in 1935 under FDR to encourage worker organizing.

(3) Powell's dovish Fed. Meanwhile, last August, the Fed reworded its dual-mandate statement to prioritize “broad based and inclusive maximum full employment” ahead of maintaining price stability. It is now aiming to overshoot inflation above the official 2% target for a while to make up for undershooting it for so many years. Fed Chair Jerome Powell is the anti-Volcker, doing whatever it takes to bring back (some) inflation.

What about a repeat of the Great Inflation of the 1970s as a result of the current administration's policies? It could happen. However, that decade was uniquely inflation prone. Nixon devalued the dollar on August 15, 1971. The resulting surge in commodity prices was exacerbated by a food price shock (1972-73) followed by two oil price shocks (1973 and 1979). During the 1970s, strong labor unions in the private sector succeeded in quickly boosting wages through cost-of-living clauses in their contracts. Productivity growth collapsed during the decade. The result was an inflationary wage-price spiral [1].

This time may not be different. The dollar is down 12.3% since it peaked on March 18, 2020. Food, energy, and industrial commodity prices are soaring. Wages inflation may be starting to pick up. Labor unions in the private sector may still be weak, but the federal government under Biden is clearly on their side.

Does all this mean that a comeback for inflation is inevitable? Or are there offsetting reasons why this might not happen? I am on the lookout for—but don’t expect—an inflationary wage-price spiral. I do expect to see wages rising more rapidly in coming months given all of the above. The main reason is that I believe that productivity growth is set to move higher during the Roaring 2020s as it did during the Roaring 1920s [2]. I expect that it will be strong enough to offset the inflationary consequences of the Biden administration's inflationary policies. So far, so good [3].

So for now, I remain in the camp anticipating a transitory rebound in the inflation rate in the 3.0%-4.0% range in coming months before it settles back down to 2.0%-2.5%. Stay tuned. ______________________

[1] See my LinkedIn article, "Inflation Was Sooo 1970s! Will It Roar Back in the 2020s?" December 12, 2020.

[2] See my LinkedIn article, "Comparative Roaring '20s," December 1, 2020.

[3] See my LinkedIn blog on productivity.

The One Percent: Off With Their Heads!

Socialists promote policies that they claim will lead to greater income equality. History shows that most countries that have embraced socialism have achieved income equality: Almost everyone is poorer than before socialism was imposed on them for their own good. Purchasing power is depressed for most people, and the quality of the goods and services they can purchase is poorer too.

Socialists often declare that the rich don't pay their “fair share” of taxes and must pay more so that the proceeds can be redistributed to boost the incomes of the poor. The problem is that the fair share that the rich must pay never seems to be enough. Higher and higher taxes on the rich result in fewer and fewer of them. Eventually, the only fat cats left are the socialist elites, who always get richer as most of the rich in the private sector get poorer. Needless to say, the poor also get poorer as a result.

In the US today, progressive politicians claim that the “One Percent” of taxpayers are compensated too much and don't pay their fair share of taxes. It's hard to deny that a few CEOs, especially the ones heading up technology and financial companies, get paid too much relative to the pay of their workers. Many professional athletes and Hollywood celebrities earn even more than top-paid CEOs. So the progressives could be right, but let’s see what the latest available data through 2018 show:

(1) Number of tax returns. The total number of all the tycoons on Wall Street, in Silicon Valley, in Hollywood, and on the playing fields—including everyone with adjusted gross income (AGI) exceeding $500,000 a year—was 1.65 million taxpayers in 2018, exactly 1.1% of the 153.8 million taxpayers who filed individual income tax returns that year, according to the latest available data from the Internal Revenue Service (IRS) (Fig. 1). Adjusted gross income is income from all sources before subtracting deductions and exemptions.

By the way, the number of returns showing AGI of $500,000 and over has more than doubled since 2009. The rich have been getting richer, and there are more of them. What you won't hear from progressives is that the same can be said for all the other income groups other than taxpayers earnings less than $50,000, clearly showing that there are fewer low-income tax filers! Their headcount has dropped 6.1 million since they peaked at a record 95.0 million during 2011. Since 2009, the number of returns filed by taxpayers with AGI of $50,000-$100,000 rose 5.0 million, $100,000-$200,000 rose 7.6 million, and $200,000-$500,000 rose 3.7 million.

(2) Adjusted gross income. During 2018, AGI in the US totaled $11.6 trillion. The AGI of the One Percent was $2.5 trillion during 2018, accounting for 21.7% of the total, up from 13.9% during 2009 and exceeding the previous high of 21.7% during 2007 (Fig. 2 and Fig. 3). Over that same period, the share of taxpayers reporting less than $100,000 in AGI fell from 50.7% to 36.6% of total AGI.

That’s outrageous: The One Percent earned over 20% of all national AGI during 2018! Off with their heads!

Not so fast, Robespierre.

(3) Taxes. Collectively, during 2018, the One Percent paid $639 billion in income taxes, or 25.3% of their AGI (Fig. 4 and Fig. 5). That amount represented a record 41.5% of the $1.54 trillion in federal income taxes paid by all taxpayers (Fig. 6). That’s up from 29.8% in 2009. Meanwhile, the rest of us working stiffs, the “Ninety-Nine Percent,” picked up only 58.5% of the total tax bill during 2018.

What should be the fair share for the One Percent? Instead of about 40% of the federal government’s tax revenue, should they be kicking in 50%? Why not 75%? They would be less rich, but everyone else would be richer—unless paying more in taxes caused the One Percent to work less hard or leave the country, sapping their incentive to keep creating new businesses, jobs, and wealth here in America.

(4) Taxing math. To repeat, during 2018 the One Percent reported $2.5 trillion in AGI, which accounted for 21.7% of total AGI. They paid $639 billion in income taxes, which was 25.3% of their AGI but accounted for 41.5% of total income taxes paid to the IRS.

I’m sure there are plenty of progressives who believe that the One Percent should pay at least 50% of their AGI in income taxes. That would have amounted to an extra $600 billion in their tax bill for a total of $1.25 trillion in 2018. Total tax revenues would have been $2.1 trillion, with the One Percent’s fairer share of that at 60%. There would have been plenty more tax revenues for the government to spend and redistribute.

So let’s tax the rich much more! But if their fair share is raised again and again by the progressives, what will we do when the rich are all gone?

(5) Trumped. By the way, we can slice and dice the IRS data to see how President Trump’s tax reform affected individual income tax receipts during 2018 compared to 2017, i.e., before and after tax reform. The law retained the old structure of seven individual income tax brackets, but in most cases, it lowered the rates. The top rate fell from 39.6% to 37.0%, while the 33% bracket dropped to 32%, the 28% bracket to 24%, the 25% bracket to 22%, and the 15% bracket to 12%. The lowest bracket remained at 10%, and the 35% bracket was also unchanged.

The number of tax returns increased 0.6% from 152.9 million to 153.8 million, while AGI rose 5.7% to $11.64 trillion (Fig. 7 and Fig. 8). Total individual income taxes paid fell 4.3% to $1.54 trillion as the average tax rate fell from 14.6% during 2017 to 13.2% during 2018, which was the lowest since 13.1% during 2012 (Fig. 9 and Fig. 10).

The IRS data show the following declines in the average tax rates (based on AGI) for the following income groups:

$0-$50,000 (down 0.1ppt from 0.7% to 0.6%)

$50,000-$100,000 (down 1.4ppt from 8.9% to 7.5%)

$100,000-$200,000 (down 1.5ppt from 12.6% to 11.1%)

$200,000-$500,000 (down 2.6ppt from 19.2% to 16.6%)

$500,000 and over (down 1.4ppt from 26.7% to 25.3%)

(6) Three cheers for the Five Percent! These numbers suggest that the biggest winners were in the $200,000-$500,000 AGI group, accounting for 4.5% of all tax returns in 2018. They aren’t in the One Percent. They are in the “Five Percent,” the upper middle class with many of them owning their own businesses, which tend to employ lots of people. Arguably, their tax break provided them with more cash to expand their businesses, which certainly explains why the labor market was so strong in 2018 and 2019.

The Biden administration has pledged that the tax increases it intends to enact will only hit taxpayers earning more than $400,000 per year. The problem is that lots of these people tend to have their own businesses. The latest data available show there were just under 32 million pass-through businesses in 2013, almost 20 times the number of C corporations. There are surely many more such proprietorships today. An increase in their tax bills reduces the cash that they have to invest in growing their businesses. One way or another, a tax increase on them will hurt the wages and employment opportunities of lots of people earning much less than $400,000. Tax increases on the rich inevitably trickle down to the rest of us.

But at least there will surely be more income equality.

Running of the Bulls

Prince, Bowie, or Metallica? I’m still trying to figure out what will be the theme song for 2021. I’d been thinking “Party Like It’s 1999” by Prince until last week, when I suggested that “Space Oddity” by David Bowie might be more relevant if stock prices continue to hurtle into outer space. Either song would be consistent with a continuation of the bull market in stocks. Alternatively, perhaps I need to consider a far more pessimistic theme song like “For Whom the Bell Tolls” by Metallica.

There’s an old stock market adage: “They don’t ring a bell at the top.” My study of financial history suggests that the adage isn’t true: Credit crunches serve as bells. More specifically, financial crises that trigger a widespread credit crunch tend to cause bear markets in stocks as investors correctly anticipate that the credit crisis will cause a recession (Fig. 1). During credit crunches, the S&P 500 VIX, a measure of stock market volatility, tends to soar along with the yield spread between high-yield bonds and the 10-year Treasury bond (Fig. 2).

While the VIX doesn’t rise on a predictable schedule as does the sun, its rising can also shed light. In addition to rising during bear markets, it also rises during stock market corrections and minor panic attacks (Fig. 3 and Fig. 4). Since the start of the bull market in 2009, Joe and I have counted 69 panic attacks. The latest one occurred when the Nasdaq fell 10.9% from February 12 through March 8, mostly on jitters over the backup in bond yields. By the way, we count last year’s selloff as a panic attack rather than an outright bear market. (See Table of S&P 500 Panic Attacks Since 2009.)

The unusual frequency of panic attacks during the current bull market suggests that investors have remained jittery ever since the last bear market during the Great Financial Crisis (GFC) and prone to hear warning bells. Ernest Hemingway, who wrote the novel For Whom the Bell Tolls (1940), suffered from tinnitus, a constant ringing in his ears as a result of injuries sustained in World War I. Similarly, investors traumatized by the GFC remain easily convinced that another bear market is imminent.

No alt text provided for this image Yet despite their propensity to panic, stock market investors are reveling in a festive mood with the bulls stampeding. Hemingway’s The Sun Also Rises (1926) portrays American and British expatriates who travel from Paris to the Festival of San Fermín in Pamplona, Spain, to watch the running of the bulls and the bullfights; merrymaking in the festive atmosphere provides them with an escape from reality, for the time being.

Contrarians aren’t indulging in the stock market’s revelry; they see too many indicators flashing that stock market sentiment is unduly bullish. For them, the sun will soon set, providing a good reason to take profits before darkness.

On the other hand, there is plenty of liquidity to drive stock prices higher without a significant correction. M2 is up by an unprecedented $4.2 trillion y/y through February (Fig. 5). Furthermore, over the past 12 months through February, personal saving totaled a record-shattering $3.1 trillion. All that occurred before the third round of relief checks ($1,400 per eligible person) was sent by the Treasury to over 250 million Americans since mid-March.

MAMU, here we come! In my latest book, The Fed and the Great Virus Crisis, I predicted that MMT + TINA = MAMU, where MMT = Modern Monetary Theory, TINA = there is no alternative to stocks, and MAMU = the Mother of All Meltups. (See the relevant excerpt.)

That might turn out to be the new adage for our times. Now let’s have a look at the latest running of the bulls:

(1) Party like it’s 1999. The Nasdaq continues to party like its 1999 (Fig. 6). The tech-heavy index is up 104.8% since March 23, 2020 through Friday’s close. The Nasdaq bottomed on October 8, 1998 following the Russian debt and LTCM crisis. It was up 113.4% on a comparable temporal basis to the current bull run. If the Nasdaq’s bull run is about to turn into a stampede, as happened during the last leg of the 1999/2000 bull market, then it could double in value over the next six to nine months as it did back then. The S&P 500 is up 87.1% since March 23, 2020 through Friday’s close. That’s well ahead of 1999, when it was up 33.4% on a comparable temporal basis (Fig. 7).

(2) Stretched valuation. The S&P 500’s forward P/E continues to fluctuate around 22.0, as it has over the past year. That’s not far off its record 25.7 valuation multiple during April 1999. On the other hand, the forward price-to-sales ratio of the S&P 500 has been setting new record highs for most of the past year, rising to 27.9 on Friday (Fig. 8).

(3) Bullish sentiment running wild. The Bull/Bear Ratio compiled by Investors Intelligence was relatively elevated at 3.77 during the week of April 13 (Fig. 9). By historical standards, the percentage of bulls was particularly high at 63.4%. Bears are relatively scarce at 16.8%, as are investors expecting a correction at 19.8%.

The running of the bulls is even more discernible in the Bull/Bear ratios based on survey data compiled by the American Association of Individual Investors (Fig. 10).

(4) Fun for almost everyone. Measures of market breadth show that the bull market has broadened since early last September. The ratio of the equal-weighted to the market-cap weighted S&P 500 stock price indexes has been rising since it bottomed on September 1 (Fig. 11). The percentage of S&P 500 stock prices above their 200-day moving averages (dma) rose to 96.2% on April 16, exceeding the 96.0% reached on October 16, 2009 (Fig. 12). The S&P 500 was 15.4% above its 200-dma yesterday (Fig. 13). That’s a relatively high reading. During April 16, the percentage of S&P 500 companies with positive y/y stock prices changes was 93.1%, around previous cyclical highs (Fig. 14).

(5) Another adage. Here’s another old stock market adage: “Sell in May and go away.” While doing so might make sense this year since bullish sentiment is so high, I’ve never been a fan of this adage. It doesn’t always work, and even when it does, the investor is left with the problem of determining when to get back into the market. Proponents of the adage say to come back after October, but there have been plenty of times when that advice would have meant missing a summer rebound that followed a selloff in May.

(6) Speed bumps. The meltups in some asset prices are starting to run into some regulatory headwinds. We anticipated this might happen in the SPAC market. We last did so in the March 16 Morning Briefing. We wrote: “The bottom line is that a few of the speculative excesses in the market are under scrutiny by the regulators. The SEC is warning about SPACs with conflicts of interest, and the major central banks are warning about cryptocurrencies being used for illegal activities.”

On April 21, CNBC posted an article titled “SPAC transactions come to a halt amid SEC crackdown, cooling retail investor interest.” It noted: “After more than 100 new deals in March alone, issuance is nearly at a standstill with just 10 SPACs in April, according to data from SPAC Research. The drastic slowdown came after the Securities and Exchange Commission issued accounting guidance that would classify SPAC warrants as liabilities instead of equity instruments. If it becomes law, deals in the pipeline as well as existing SPACs would have to go back and recalculate their financials in 10-Ks and 10-Qs for the value of warrants each quarter.”

Cryptocurrencies also have had a bad case of the jitters over the past week or so on rumors that the Treasury Department could be looking to crack down on financial institutions for money laundering using cryptocurrency. During her congressional nomination hearing on January 19, Treasury Secretary Janet Yellen suggested that lawmakers “curtail” the use of cryptocurrencies such as bitcoin. Her concern is that they are “mainly” used for illegal activities, including “terrorist financing” and “money laundering.”

Adding to the jitters in most financial asset markets was President Joe Biden’s plan, announced Thursday, April 22, to raise the capital gains tax from 20.0% to 39.6% for taxpayers earning over a million dollars. Since capital gains are also subject to the 3.8% Medicare tax, the new capital gains rate would be 43.4%. Larry Lindsey, who worked for the Bush administration, described this proposed increase as a “punitive” tax on the wealth.

On the other hand, Goldman Sachs opined on Friday, April 23 that the end version likely will be something considerably less severe, which explains why stock prices rebounded that same day following the previous day’s selloff on the Biden proposal.

Outcome Rather Than Outlook; Reacting Rather Than Preempting

The Fed I: Backward Looking. Just in case we didn’t get the Fed’s memo on the change in its monetary framework, Fed Governor Lael Brainard explained it very clearly in a speech on March 23 titled “Remaining Patient as the Outlook Brightens.” Throughout her talk, she stressed very important distinctions in meaning between “outlook” and “outcome” and between “preempting” and “reacting.” She concluded her speech with her punchline: “By taking a patient approach based on outcomes [emphasis added] rather than a preemptive approach based on the outlook, policy will be more effective in achieving broad-based and inclusive maximum employment and inflation that averages 2 percent over time.”

Brainard acknowledged that the efforts of public health, fiscal, and monetary policymakers “have contributed to a considerably brighter economic outlook.” However, she stated that the Fed’s “reaction function” had changed in response to the pandemic. The Fed governor explained: “The FOMC has communicated its reaction function under the new framework and provided powerful forward guidance that is conditioned on employment and inflation outcomes. This approach implies resolute patience while the gap closes between current conditions and the maximum-employment and average inflation outcomes in the guidance.”

In effect, the Fed’s policy responses will be backward looking rather than forward looking. In an April 11 interview on CBS 60 Minutes, Fed Chair Jerome Powell reiterated this message as follows:

(1) Inflection point. He started with a very upbeat outlook: “What we’re seeing now is really an economy that seems to be at an inflection point. And that’s because of widespread vaccination and strong fiscal support, strong monetary policy support. We feel like we’re at a place where the economy’s about to start growing much more quickly and job creation is coming in much more quickly.” He concluded the interview by saying “I’m in a position to guarantee that the Fed will do everything we can to support the economy for as long as it takes to complete the recovery.”

(2) Recovery redefined. Got that? The Fed will keep policy ultra-easy until the recovery is complete. But wait a minute—real GDP is likely to be back in record-high territory by the second quarter. It is on the verge of a complete recovery. That’s true, but Powell and Brainard said that “broad-based and inclusive maximum employment” is one of the outcomes they want to see before the Fed starts tightening. Both also want to see inflation moderately above 2%. Powell explained: “And the reason for that is we want inflation to average 2% over time.”

(3) Fed funds rate staying put. Once the Fed achieves this outcome, “that’s when we’ll raise interest rates,” Powell said. When asked whether interest rates might remain unchanged around zero through year-end, Powell said, “I think it’s highly unlikely we would raise rates anything like this year, no.”

The Fed II: Ghost of Greenspan Past. What about asset inflation? In his interview, Powell was asked about it and responded: “[W]e do look at asset prices. And I would say, you know, some asset prices are elevated by some historical metrics. Of course, there are people who think that the stock market is not overvalued, or it wouldn’t be at this level. We don’t think we have the ability to identify asset bubbles perfectly. So … what we focus on is having a strong financial system that’s resilient to significant shocks, including if values were to go down.”

What about Archegos? This hedge fund, disguised as a “family office,” blew up earlier this month when its speculative bets in the stock market crashed and burned, leaving billion-dollar craters in the earnings of a few of its brokers. Powell’s response gave me an unsettling sense of déjà vu all over again. He said:

“This is an event that we’re monitoring very carefully and working with regulators here and around the world to understand carefully. What’s concerning about it … and surprising, frankly, is that a single customer, client, of one of these large firms could result in such substantial losses to these large firms in a business that is generally thought to present relatively well understood risks.”

That reminds me of the following remarks by Alan Greenspan for his October 23, 2008 testimony before the House Committee on Oversight and Government Reform at a hearing on the role of federal regulators in the Great Financial Crisis:

“As I wrote last March: those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity (myself especially) are in a state of shocked disbelief. Such counterparty surveillance is a central pillar of our financial markets’ state of balance. If it fails, as occurred this year, market stability is undermined.”

During his Q&A exchange, Greenspan acknowledged the error of his ways: “I made a mistake in presuming that the self-interest of organizations, specifically banks and others, [was] such [that] they were best capable of protecting their own shareholders and their equity in the firms.”

(For more thoughts regarding that testimony, see my 2020 book Fed Watching for Fun and Profit, particularly Chapter 5 titled “Alan Greenspan: The Great Asset Inflator.” Chapter 8 is titled “Jerome Powell: The Pragmatic Pivoter.” When and if I write a second edition, I might have to change that to “Jerome Powell: Another Great Inflator.” His policies have the potential to inflate not only asset prices but also consumer prices.)

The Fed III: New Monetary Policy Approach. All this amounts to a backward-looking, rather than a forward-looking, monetary policy approach. Ironically, all the talking Fed heads now are saying that their “forward guidance” is no longer relevant since that was based on their outlook, which has not been relevant since the pandemic started. What matters now is the outcome, which can only be known after it happens!

Forward-looking guidance has now morphed into backward-looking guidance. In effect, Fed officials are saying, “We’ll let you know when we are ready to raise interest rates after we get the outcome we were seeking.”

Confused? If not, you should be. Now take a deep breath and try to fathom the following Fed speak from a March 25 speech by Fed Vice Chair Richard Clarida:

“The changes to the policy statement that we made over the past few FOMC meetings bring our policy guidance in line with the new framework outlined in the revised Statement on Longer-Run Goals and Monetary Policy Strategy that the Committee approved last August. In our new framework, we acknowledge that policy decisions going forward will be based on the FOMC’s estimates of ‘shortfalls [emphasis added] of employment from its maximum level’—not ‘deviations.’ This language means that going forward, a low unemployment rate, in and of itself, will not be sufficient to trigger a tightening of monetary policy absent any evidence from other indicators that inflation is at risk of moving above mandate-consistent levels. With regard to our price-stability mandate, while the new statement maintains our definition that the longer-run goal for inflation is 2 percent, it elevates the importance—and the challenge—of keeping inflation expectations well anchored at 2 percent in a world in which an effective-lower-bound constraint is, in downturns, binding on the federal funds rate. To this end, the new statement conveys the Committee’s judgment that, in order to anchor expectations at the 2 percent level consistent with price stability, it will conduct policy to achieve inflation outcomes that keep long-run inflation expectations anchored at our 2 percent longer-run goal.”

You can come up for air now.

The Fed IV: By the Numbers. The Fed’s balance sheet continues to expand to infinity and beyond. That’s been happening since the Fed adopted QE4ever on March 23, 2020. Here are the mind-boggling relevant stats since then through the April 7 week:

(1) Assets. The assets side of the Fed’s balance sheet is up $3.0 trillion over this period to a record $7.7 trillion (Fig. 1). The Fed’s holdings of securities is up $3.2 trillion to a record $7.1 trillion. The difference between these two series is composed mostly of the assets held by the Fed’s emergency liquidity facilities, which has declined $167 billion since March 23, 2020 (Fig. 2). It remains $260 billion above last year’s low during the week of February 26.

(2) MMT. Over the past 12 months through March, the US federal budget deficit totaled $4.1 trillion (Fig. 3). The Fed financed 51% of this deficit by purchasing $2.1 trillion in US Treasury securities over this period. As of March, the Fed held a record 25.6% of the total of marketable US Treasury debt (Fig. 4). That’s Modern Monetary Theory (MMT) on speed and steroids.

(3) Notes and bonds. Over the past 12 months through March, the Treasury issued $2,081 billion in notes and bonds (Fig. 5 and Fig. 6). Over that same period, the Fed purchased $1,615 billion in the Treasury’s notes and bonds. It bought them in an effort to keep a lid on bond yields. The 10-year Treasury bond yield has rebounded nonetheless, but it would probably be higher today but for the Fed’s purchases.

(4) Reserve balances. As a result of the Treasury’s record budget deficit and the Fed’s record purchases of securities, the total deposits at all US commercial banks has increased $2.4 trillion y/y to a record $16.7 trillion through the March 31 week (Fig. 7). Another result of T-Fed’s MMT on speed and steroids is that reserve balances with the Fed has jumped $1.2 trillion y/y to a record $3.9 trillion during the April 7 week (Fig. 8). That well exceeds the impact of the previous three QE programs on reserve balances.

(5) The others. Meanwhile, the assets on the ECB’s balance sheet also continue to soar. During the April 2 week, this series was up €2.3 trillion y/y to a record €7.5 trillion (Fig. 9). The BOJ’s assets rose 18% y/y to a record ¥714 trillion during the March 26 week (Fig. 10).

I also track the assets of the People’s Bank of China (PBOC). However, we believe that China’s bank loans data are a more useful measure of the PBOC’s ultra-easy monetary policy since the Great Financial Crisis. From the end of 2008 through March 2021, they are up a staggering $23.3 trillion from $4.4 trillion to a record $27.7 trillion (Fig. 11). Over the past 12 months through March, these loans are up a record $3.1 trillion (Fig. 12).

All together in US dollars, the assets of the Fed, ECB, and BOJ are up $6.9 trillion y/y through the March 26 week to a record-high $23.1 trillion (Fig. 13 and Fig. 14).

The Myth of Stagnating Real Wages

In the past, I often have observed that, contrary to popular belief, inflation-adjusted wages have been expanding rather than stagnating for many years. Wage stagnation has been a popular myth perpetuated by progressives bemoaning workers’ plight to promote their own political agenda.

Naturally, progressives want even more progressive income taxes on higher-income workers and more social benefits for lower-income ones. Their goal is to redistribute income to reduce income inequality. They’ve actually succeeded in doing so, but they never seem to be satisfied. They always want more taxes and more benefits. The result is more “big government.” For now, let’s update the data that belie their basic claims:

(1) The wrong measure of inflation-adjusted wages. One measure of real wages seems to confirm the progressives’ stagnation thesis. Inflation-adjusted wages—defined as AHE divided by the CPI—peaked at a then-record high of $23.49 per hour during January 1973 (Fig. 1). It remained below that level until April 2020. That’s over 47 years! As of February 2021, it was only 1.4% above the 1973 peak. That’s pathetic.

I mean that analysis is pathetic. The CPI is widely known to be biased to the upside. A far better measure of consumer prices is the PCED. When we use that series to deflate the AHE series, we find that inflation-adjusted wages did stagnate during most of the 1970s through the mid-1990s. But it started moving higher around 1995 and has been achieving new highs since January 1999, rising along a trend line of 1.2% per year (Fig. 2).

(2) Rising standard of living. That represents a very solid increase in the purchasing power of consumers and in their standards of living! The real wage has increased 38% over the past 26 years from $16.18 during February 1995 to $22.34 during February 2021. Keep in mind that I am using AHE for production and nonsupervisory workers, who account for roughly 80% of private payrolls. This series certainly isn’t upwardly biased by the earnings of higher-wage workers.

Data available since 2006 show that AHE for higher-wage workers, on an inflation-adjusted basis using the PCED, rose 12.0% from the start of that year through February of this year (Fig. 3). Over the same period, AHE rose 19.5% for lower-wage workers.

Any way we slice or dice the data, the conclusion is the same: The income stagnation story is a myth. Standards of living have been rising for most Americans most of the time.

High-Octane Earnings

I am raising my S&P 500 operating earnings forecast for 2021 from $175 per share to $180, a 27.8% y/y increase from 2020. I am also raising my 2022 forecast from $190 to $200, an 11% increase over my new earnings target for this year. I would have raised my 2022 estimate more but for my expectation that the Biden administration will raise the corporate tax rate next year.

As I've observed, the economy was hot before the third round of “relief” checks started going out around mid-March. Now it is likely to turn red hot as the Treasury sends $1,400 checks or deposits to 285 million Americans in coming weeks.

I have also observed that the average of the business activity indexes compiled by the Federal Reserve Banks (FRBs) of New York and Philadelphia for their districts jumped from 17.6 during February to 34.6 during March, the highest reading since July 2004 (Fig. 1). This is a very significant development for the following reasons:

(1) Regional and national business surveys. Their average tends to be a good leading indicator for the average of the five surveys conducted by these two FRBs along with the ones in Richmond, Kansas City, and Dallas. The average of the five business activities indexes is highly correlated with the national M-PMI (Fig. 2). That means that the average of the New York and Philly indexes also is highly correlated with the national M-PMI and is signaling a solid number for the latter’s March reading (Fig. 3).

(2) Business indexes and S&P 500 revenues growth. “What does this have to do with S&P 500 earnings?,” you might be wondering. Good question. I won’t keep you in suspense. Previously, I’ve observed that the M-PMI is highly correlated with the y/y growth rate in S&P 500 aggregate revenues (Fig. 4). February’s M-PMI reading of 60.8 matches some of the best readings in this indicator since 2004! The March reading could be stronger, implying that S&P 500 revenues may be set to grow 10%-15% this year. That’s certainly confirmed by the similar relationship between the growth in revenues and the average of the New York and Philly business activity indexes (Fig. 5).

(3) Profit margin. That strong outlook for revenues growth provides a very good tailwind for earnings growth, which will also get a lift from a rising profit margin. I think that the profit margin, which averaged 10.4% last year, could increase both this year and next year. Profit margins tend to rebound after recessions and during recoveries along with productivity.

(4) Bottom line on the bottom line. Let’s put it all together now. I am raising my S&P 500 revenues forecast by $50 to $1,550 per share this year, up 14.0% from the 2020 level (Fig. 6). For next year, I am sticking with my $1,600 revenues estimate, representing just a 3.2% increase. That’s because I believe that the relief checks, besides relieving pent-up demand, will pull forward some of next year’s demand. Also, individual tax rates are likely to go up next year along with corporate ones.

I am projecting that the S&P 500 profit margin will increase from 10.4% last year to 11.6% this year and 12.5% next year (Fig. 7). The result would be S&P 500 earnings of $180 per share this year and $200 next year (Fig. 8). (See YRI S&P 500 Earnings Forecast.)

Analysts Bullish on S&P 500 Fundamentals

I am not the only one turning even more bullish on the fundamentals driving the stock market. Industry analysts also are raising their estimates for revenues, earnings, and profit margins for the S&P 500 for this year and next year. Consider the following:

(1) Quarterly consensus earnings estimates for 2021. The analysts’ consensus estimates for quarterly S&P 500 earnings per share this year have been rising since mid-2020 (Fig. 9). As of the March 18 week, they were projecting the following y/y growth rates for S&P 500 operating earnings: Q1 (20.0%), Q2, (50.1), Q3 (18.0), and Q4 (12.5) (Fig. 10).

(2) Annual consensus earnings estimates for 2021 and 2022. As of the March 18 week, the consensus predicted that S&P 500 earnings per share will be $175.54 this year and $202.11 next year (Fig. 11). Currently, industry analysts are expecting that S&P 500 earnings will increase 25.5% this year compared to last year (Fig. 12). For 2022, they are anticipating a 15.2% growth rate.

(3) Annual consensus revenues and margin estimates for 2021 and 2022. Industry analysts are currently projecting that revenues will total $1,459.08 this year and $1,558.19 next year (Fig. 13). In other words, they are expecting revenues per share to grow 9.4% in 2021 and 6.8% during 2022 (Fig. 14).

Interestingly, their estimate for 2021 revenues growth has been increasing since the week of November 19, undoubtedly reflecting expectations that President Biden’s American Rescue Plan would be enacted early this year and be very stimulative, adding roughly two percentage points to revenues growth. The expected growth rate for 2022 hasn’t changed much since late last year.

I calculate the implied profit margins from the consensus estimates for earnings and revenues. The results show that margin estimates have been improving since last summer for 2020, 2021, and 2022. The latest readings for these in 2021 and 2022 are 11.8% and 12.7% (Fig. 15).

(4) Forward ho! Both S&P 500 forward revenues and forward earnings have now fully recovered what they lost during the first few months of the pandemic (Fig. 16). Both took much longer to recover during the Great Financial Crisis. The same can be said for the forward profit margin. The weekly forward revenues, earnings, and profit margin series are all excellent coincident indicators of the comparable actual comparable data (Fig. 17). All three of the weekly series remain bullish on the underlying fundamentals for the S&P 500.

I am raising my year-end 2021 and 2022 forward earnings forecasts by $5 each to $200 and $210 (Fig. 18). Think of these as my best guess of what industry analysts will be projecting earnings will be in 2022 and 2023 at the end of 2021 and 2022. (See our 2020 study titled S&P 500 Earnings, Valuation, & the Pandemic for a thorough explanation of forward earnings.)

(5) S&P 500 targets and valuation. Even though I am raising my forward earnings targets, I am keeping my S&P 500 stock price targets at 4300 and 4800 by the end of this year and next year. That buys me a bit more wiggle room on our valuation multiple assumptions, which are now 21.5 and 22.9 for the end of this year and next year (Fig. 19). The multiple is currently 21.6.

One of my accounts asked me whether I should lower my outlook for the forward P/E given that I am predicting that the 10-year US Treasury bond yield is likely to rise back to its pre-pandemic range of 2.00%-3.00% over the next 12-18 months.

Normally in the past, I would have lowered my estimates for forward P/Es in a rising-yield environment. However, these are not normal times. In the “New Abnormal,” valuation multiples are likely to remain elevated around current elevated levels because fiscal and monetary policies continue to flood the financial

Rent: From Headwind To Tailwind

Rent is one of the major components of both the Consumer Price Index (CPI) and the personal consumption expenditures deflator (PCED). Rent inflation has been falling since the start of the pandemic. So it has helped to keep a lid on overall consumer price inflation. Rent disinflation has offset price increases resulting from the stimulative monetary and fiscal policies implemented by the government to shore up the financial system and to revive economic growth. So far, rent disinflation has provided a headwind for overall inflation.

However, a shortage of houses for sale combined with rapidly rising home prices and mortgage rates could soon boost rent inflation, providing a tailwind for overall inflation. Consider the following:

(1) Housing market. The pandemic triggered a wave of deurbanization. City dwellers, especially those renting apartments, suddenly decided it was time to buy a house in the suburbs. They wanted big yards with swimming pools for their kids, home offices, and more distance from their neighbors. At the same time, the Fed’s ultra-easy monetary policies caused mortgage rates to fall to record lows. That only stoked demand for houses.

During the lockdowns at the start of the pandemic, the sum of existing plus new single-family homes plunged from 5.83 million units (saar) in February 2020 to 4.35 million units in May (Fig. 1). As the lockdown restrictions were lifted, home sales soared to a high of 6.98 million units during October, the best reading since April 2006. They remained around that pace through January.

The problem is that the inventory of existing and new homes for sale fell to a record low of 1.19 million units during January (Fig. 2). Demand is seriously outstripping supply. So home prices are soaring. The median and average prices of existing single-family homes rose 14.8% y/y and 12.3% y/y through January to fresh record highs (Fig. 3). Median home prices are up at double-digit rates in the Northeast (18.4%), West (17.5), Midwest (15.1), and South (14.7) (Fig. 4).

The backup in bond yields has caused the 15-year fixed-rate mortgage yield to rise from a record low of 2.32% on January 4 to 2.54% on Friday (Fig. 5). It’s likely to keep rising along with bond yields. The combination of low inventories of homes, soaring home prices, and rising mortgage rates may already be weighing on mortgage applications to purchase homes (Fig. 6).

Building a new home has become more expensive as lumber prices have soared (Fig. 7). We’ve heard that many builders are so busy that they tell prospective new homebuyers that they won’t be able to start on their projects for 12-18 months.

(2) Rental market. In other words, the lack of availability and the declining affordability of homes could convince urban dwellers to stay put in their rental apartments. For now, some might be able to negotiate a better rental deal with their landlord. However, the rental market could tighten later this year if the availability and affordability of homes discourages would-be homebuyers.

The inflation rate of the CPI for tenant rent fell to 2.1% y/y during January, down from 3.8% a year ago (Fig. 8). Following the Great Financial Crisis (GFC) of 2008, tenant rent inflation plunged to a low of -0.1% during May 2010, down from 4.6% during March 2007.

During the GFC and for a few years following this calamity, there was a glut of distressed homes for sale. Home prices fell, and so did rents. The Great Virus Crisis boosted the demand for homes and their prices, sending rent inflation downward. But rent inflation may not have much lower to go and could be on the way up again later this year for the reasons discussed above.

(3) Rent in consumer prices. In the CPI, rent of shelter includes tenant rent and owners’ equivalent rent. The latter closely tracks the former. Rent of shelter accounts for 33.3% of the headline CPI, 41.8% of the core CPI, and 53.1% of CPI services. Rent of shelter accounts for 16.6% of the PCED, 18.8% of the core PCED, and 25.3% of PCED services.

(4) Phillips curve. Fed officials seem to be running monetary policy under the influence of the notion that the Phillips curve is dead. It wasn’t too long ago that they believed that inflation is inversely correlated with the unemployment rate. The only question in their minds was whether this relationship had flattened in recent years given that record-low unemployment prior to the pandemic wasn’t heating up inflation after all, as they previously had feared.

Now Fed officials believe that they should continue to overheat the economy with monetary policy to achieve maximum employment by next year; yet any pickup in inflation will be transient. I tend to agree with them. However, for the record, there still is an inverse relationship between the jobless rate and the inflation rate of rent of shelter in the CPI (Fig. 9). Furthermore, there is a direct relationship between wage inflation and rent inflation (Fig. 10).

During February, the unemployment rate remained high at 6.2%. However, average hourly earnings rose at a fast pace of 5.3% y/y during the month. We’ve previously suggested that generous government unemployment benefits are keeping people from seeking jobs, resulting in labor shortages. That would explain why wage inflation might remain high. If so, then that could soon cause rent inflation to stop falling and start moving higher. The headwind for overall inflation could turn into a tailwind!

Checks Without Balances

Washington’s lawmakers have discovered the joys of sending checks to their constituents during bad times. They’ve done it twice so far since the start of the pandemic and are likely to do it a third time shortly. The $1,200-per-person checks sent during April did work to revive the economy from last year’s two-month recession during March and April. The $600 checks sent during January certainly averted any stalling in economic growth in the face of the third wave of the pandemic. It’s not hard to guess what another round of $1,400 checks will do to the economy. Consider the following:

(1) Pandemic. On a 10-day moving average basis, Covid-19 hospitalizations have plunged 55% from a record high of 130,386 during January 15 to 58,394 during February 26 (Fig. 1). That’s the lowest pace since November 12, 2020. The Food and Drug Administration on February 27 authorized Johnson & Johnson’s single-shot Covid-19 vaccine for emergency use. J&J will provide the US with 100 million doses by the end of June. When combined with the 600 million doses from the two-shot vaccines made by Pfizer-BioNTech and Moderna slated to arrive by the end of July, there will be more than enough shots to cover any American adult who wants one this summer.

The new vaccine’s 72% efficacy rate in US clinical trials falls short of the roughly 95% rate found in studies testing the Moderna and Pfizer-BioNTech vaccines. Across all trial sites, the Johnson & Johnson vaccine also showed 85% efficacy against severe forms of Covid-19 and 100% efficacy against hospitalization and death. That sounds like a winner for sure! To repeat: 100% efficacy against hospitalization and death. That should turn the plague into a pest by the second half of this year.

In his February 23 congressional testimony on monetary policy, Fed Chair Jerome Powell said, “While we should not underestimate the challenges we currently face, developments point to an improved outlook for later this year. In particular, ongoing progress in vaccinations should help speed the return to normal activities.” I think that both monetary and fiscal policymakers underestimate the stimulative impact of the end of the pandemic.

(2) Real GDP. The V-shaped recovery in real GDP will remain V-shaped during the first half of this year and probably through the end of the year. However, it will no longer be a “recovery” beyond Q1 because real GDP will have fully recovered during the current quarter. Thereafter, GDP will be in an “expansion” in record-high territory.

Last year, real GDP rebounded 33.4% (saar) during Q3 and 4.1% during Q4 (Fig. 2). We are projecting 7.0% during Q1. On Monday, we raised our Q2 estimate from 4.5% to 9.0%, mostly because we expect that President Biden’s American Rescue Plan will be enacted in the next few weeks.

The plan will provide checks of $1,400 per eligible person, mostly during April, we reckon, providing another big boost to consumer incomes and spending. Last year, consumer spending in real GDP rose 41.0% during Q3 and 2.4% during Q4. The Atlanta Fed’s GDPNow model showed an 8.8% increase in such spending during Q1 as of March 1 (with real GDP up 10.0%). We forecast that real consumer spending will increase 7.9% during Q1 and 11.3% during Q2.

(3) Personal income. In current dollars, personal income jumped by a record 12.4% m/m during April 2020 as a result of a $3.3 trillion (saar) increase in government social benefits that month, thanks to the $1,200 checks and generous unemployment benefits (Fig. 3 and Fig. 4). January’s 10.0% increase in personal income was the second biggest ever in a month, as a result of a $2.0 trillion increase in benefits attributable to the $600 checks.

If the next round of $1,400 checks goes out in April, it will undoubtedly boost personal income by a new record amount to another record high! The “other” component of government social benefits in personal income includes an item for “Economic Impact Payments” (Fig. 5). At an annual rate, these checks from the Treasury boosted benefits and total personal income by $2.6 trillion and $0.6 trillion, respectively, during April and May of last year. They boosted them both by $1.7 trillion during January. So they accounted for virtually the entire $1.9 trillion increase in personal income during January!

(4) Personal consumption. The government checks certainly contributed to the V-shaped recovery in consumer spending (Fig. 6). Another round of checks will do the same this spring. In current dollars, consumer spending rose 2.4% m/m during January, led by a 5.8% m/m increase in consumption of goods to a new record high. In coming months, consumers should be able to spend much more on services that have been limited by the pandemic’s social-distancing protocols.

(5) Personal saving. During last year’s lockdowns, consumers couldn’t spend either their paychecks or government benefits as readily as usual since most stores and restaurants were closed. So personal saving soared to a record $6.4 trillion (saar) during April (Fig. 7). It then fell to $2.3 trillion by December, which was still well above the $1.3 trillion pace of personal saving at the start of last year.

Interestingly, January’s $2.0 trillion jump in government social benefits coincided with a $1.6 trillion increase in personal saving to $3.9 trillion, suggesting that much of the month’s stimulus hasn’t been spent yet. After the year-end holiday season, January is not a prime month for shopping.

So there is plenty of stimulus left over. In addition, consumer revolving credit outstanding dropped $118 billion y/y through December to $976 billion (Fig. 8). The ratio of consumer revolving credit to personal consumption (both in current dollars) dropped from 7.4% to 6.7% over this period (Fig. 9). This suggests that consumers aren’t as reliant on their credit cards because they have plenty of cash. Moreover, once they spend their extra cash, they can always tap into their credit cards again.

(6) Unemployment benefits. The Biden plan will extend temporary pandemic relief programs for unemployed workers, expiring on March 14, to August 26. Benefit recipients would also get an extra $400 a week. More than 19 million Americans were collecting benefits as of early February, according to the Labor Department. Last year, unemployment benefits in personal income totaled $550.2 billion, up from $27.7 billion during 2019.

Our February 9 Morning Briefing was titled “The Government Is Here To Help.” We reviewed the recent Washington Post op-ed by economist Larry Summers in which he trashed President Biden’s American Rescue Plan as too stimulative and too inflationary. He also strongly implied that the plan included overly generous unemployment benefits that would discourage the unemployed from taking jobs. In fact, there is mounting evidence that the pandemic-related unemployment benefits provided last year have been doing the same.

Our February 10 Morning Briefing was titled “Help Wanted.” We wrote, “There actually seem to be lots of job openings, but fewer people willing to take them. That would explain why wages have been rising at a faster pace in recent months.”

(7) Bottom line. There is plenty of stimulus left in the pipeline from last year’s pandemic rescue programs. More rounds of government stimulus programs this year are likely to cause a boom that overheats the post-pandemic economy, which might result in higher inflation. The government’s overly generous extended unemployment benefits could frustrate policymakers’ goal of achieving full employment while driving up wage inflation.

Too much of a good thing is often just too much. The economy is hot and will get hotter with the bonfire of the fiscal and monetary insanities.

S&P 500 Earnings: V-Shaped Recovery

On the health front of the world war against the virus (WWV), the third wave of the pandemic, which started around Halloween, has been the worst by far (Fig. 1). However, it crested on January 15, when the 10-day moving average of hospitalizations peaked at 232,583. This series was down 56% to 101,407 on February 15. That’s encouraging. Hopefully, there won’t be another wave related to the Super Bowl. Meanwhile, the pace of vaccinations is picking up, which should change Covid-19 from a plague to a pest.

Notwithstanding the severity of the third wave of the pandemic during the fourth quarter of last year and early this year, a great deal of progress has been made on the economic front of WWV. The US continues to trace out a V-shaped recovery. The same can be said about the global economy. That’s showing up in the V-shaped recovery in S&P 500 earnings. So the V-shaped rebound in the S&P 500 stock price index has been justified by the rebound in earnings. The index hasn’t been disconnected from the economy as widely believed.

Of course, the remarkable progress made on the financial front of WWV in both the stock and credit markets has been largely driven by the unprecedented stimulus provided by fiscal and monetary policies around the world. Credit-quality yield spreads have narrowed, and corporate and municipal bond yields have dropped to pre-pandemic readings. The financial system and global economy are awash in liquidity, resulting in elevated valuation multiples.

Let’s review the V-shaped recovery in S&P 500 revenues, earnings, and profit margins:

(1) Q4 earnings season. Let’s start with the Q4 reporting season. So far, 369 of the S&P 500 companies have reported. During the week of February 11, S&P 500 earnings for the quarter came in at $42.26 per share using the blend of actual and estimated earnings (Fig. 2). That’s up 14.6% from the estimate during the week of December 31, just prior to the latest season. Remarkably, the latest blended earnings number for Q4 is up 0.6% y/y! That follows the following declines during the previous three quarters: Q1 (-15.4%), Q2 (-32.3), and Q3 (-8.2) (Fig. 3).

That certainly was a V-shaped recovery in the quarterly earnings-per-share numbers last year, although 2020’s total was down 14% to $140 per share from $163 in 2019. We are predicting $175 for this year, which would be a 25% rebound from last year’s total.

(2) Forward revenues and earnings. Also showing V-shaped recovery formations are S&P 500’s forward revenues and forward earnings, i.e., the time-weighted average of consensus estimates for this year and next year (Fig. 4). Both certainly stand out as V-shaped compared to their U-shaped recoveries during the Great Financial Crisis.[1]

Forward revenues per share is a great weekly coincident indicator of actual S&P 500 revenues per share (Fig. 5). During the week of February 4, the former was only 0.5% below its record high during the week of March 5.

Forward earnings per share is a great weekly year-ahead leading indicator of actual S&P 500 operating earnings on a four-quarter trailing basis (Fig. 6 and Fig. 7). Admittedly, it doesn’t see recessions coming, but it works very well during economic recoveries and expansions. It was $176.78 during the week of February 11, only 1.2% below its record high during the week of January 30, 2020. That latest number is about the same as our forecast for the year.

(3) Profit margin. Apparently, companies scrambled to cut their costs when the pandemic hit only to find that their sales recovered sooner than expected. That explains why the S&P 500 forward profit margin plunged from 12.0% at the start of 2020 to 10.3% during the week of May 28 and rebounded back to 11.9% during the week of February 4 (Fig. 8). Here are the latest analysts’ consensus profit margin estimates for 2020 (10.2%), 2021 (11.7%), and 2022 (12.7%) (Fig. 9).

Help Wanted

In a recent Washington Post op-ed, Larry Summers trashed President Joe Biden’s American Rescue Plan as too stimulative and too inflationary. He also strongly implied that the plan included overly generous unemployment benefits that would discourage the unemployed from taking jobs. In fact, there is mounting evidence that the unemployment benefits provided by the CARES (Coronavirus Aid, Relief, and Economic Security) Act have been doing the same.

There actually seem to be lots of job openings, but fewer people willing to take them. That would explain why wages have been rising at a faster pace in recent months. At the start of the pandemic, many low-wage workers lost their jobs, while most high-wage workers could work from home. That explained the jump in average hourly earnings during March and April, for sure. But now, wages may be getting a boost from a shortage of workers. Of course, contributing to the problem may be a mismatch between the skills required for the available jobs and the skills of available workers.

This is obviously a controversial subject. Undoubtedly, there are many people who have lost their jobs and can’t find new ones. It makes sense to target government stimulus support to them until the pandemic is over. Now let’s see what the data have to say on this subject:

(1) Wages and salaries. Despite January’s disappointing payrolls report, our Earned Income Proxy (EIP) for wages and salaries in the private sector rose 1.1% m/m and 0.6% y/y, its first positive reading since last March. It had bottomed at -8.9% y/y last April (Fig. 1). Private-sector wages and salaries in personal income already rose to a record high during December and probably did so again in January according to our EIP!

How can this be? Payroll employment in January was still down 9.6 million y/y, with 10.1 million people still unemployed, i.e., 4.3 million more than at the start of 2020. And the labor force was down 4.3 million from a year ago. Yet private wages and salaries in personal income rose 3.2% y/y in December (Fig. 2).

(2) Hourly wages. The measures of hourly wages all jumped during March and April as low-wage workers bore the brunt of the job losses from the lockdowns (Fig. 3). That might still explain the solid y/y percent increases in average hourly earnings for all workers (5.4% through January), average hourly earnings for production and nonsupervisory workers (also 5.4% through January), and hourly compensation in nonfarm business (7.8% through Q4).

However, there is mounting evidence that wages may be starting to get a boost from a shortage of workers willing to take jobs, perhaps because they can make more with government unemployment benefits, as Summers suggested.

(3) Payroll tax receipts. Allow me to keep you in suspense while I also observe that despite the terrible numbers of unemployed workers and labor market dropouts, total payroll taxes rose to a record high of $1.48 trillion (saar) in personal income, more than reversing its Covid-related decline and exceeding the previous record high during October 2008 by 48%! The 12-month sum of just federal payroll tax receipts rose to a record $1.34 trillion during December, up 6.2% y/y (Fig. 4). Both had declined sharply during the Great Financial Crisis (GFC) and remained weak during the subsequent recovery.

How can this be? Perhaps many of the job losses have occurred for low-wage workers who were paid off the books in cash. In addition, unemployment income is taxable, and many beneficiaries may have elected to have the payroll taxes withheld from their benefit checks.

(4) Income tax receipts. Individual income tax receipts in personal income have rebounded along with personal income and were down only 2.4% during December from last February’s record high (Fig. 5). The 12-month sum of federal income tax receipts also rebounded but was still down 10.9% during December compared to the record high last March.

(5) Small businesses. Yesterday, the National Federation of Independent Business (NFIB) released its January survey of small business owners. Overall, it was a downbeat report, with the Small Business Optimism Index taking a dive during January (Fig. 6). Many of the small business owners in the NFIB survey reported being depressed about poor sales and higher taxes (Fig. 7).

Yet remarkably, when asked about their staffing, 33.0% of respondents said they have job openings (Fig. 8). The net percent of small businesses hiring over the next three months was 17.0% last month. The percent with few or no qualified applicants for job openings was 46.0%. All these readings are within shouting distance of their pre-pandemic peaks. They rebounded dramatically following the lockdowns. Truly amazing!

(6) Indeed. Yesterday, The Wall Street Journal reported, “The number of help-wanted ads returned to pre-pandemic levels in January, particularly among industries that have weathered the pandemic relatively well, a sign that hiring could pick up from its sluggish pace at the start of the year. Available jobs on job-search site Indeed were up 0.7% at the end of January from Feb. 1, 2020, according to the company’s measure of job posting trends. The number of postings to the site has grown since hitting a low in May, though the pace of new openings has slowed in recent months, Indeed said.”

(7) JOLTS. I saved the best for last. Yesterday’s JOLTS report for December provided plenty of jolts on developments in the labor market. JOLTS is the Job Openings and Labor Turnover Survey compiled monthly by the Bureau of Labor Statistics.

For starters, total job openings rebounded from last year’s low of 5.0 million during April to 6.6 million during December (Fig. 9). It’s up 1.4% y/y. That represents a V-shaped recovery, especially compared to the experience during and after the GFC.

The number of unemployed workers as a ratio of job openings fell to a record low of 0.81 during October 2019 (Fig. 10). It jumped to peak last year at 4.63 during April. It was back down to 1.62 during December. The conclusion is that there are more jobs available and fewer unemployed workers competing for them in recent months.

(8) Causalities. By pointing out the above, I don’t mean to diminish the pain and suffering experienced by lots of people on the health, financial, and economic fronts of the world war against the virus. Our labor market has too many unemployed people and too many people who have been forced out of the labor force by the pandemic’s lockdowns of schools and businesses.

On a y/y basis through January, the labor force is down 4.3 million, with women accounting for 58% of the drop. Many no doubt had to quit jobs to take care of children whose schools were operating online only. Also, many individuals in the high-risk age group may have decided to retire early, especially those in face-to-face jobs like teaching.

We can see that in the JOLTS report, where the number of quits jumped from last year’s low of 1.9 million in April to 3.3 million in December (Fig. 11). The quit rate is especially high in the leisure & hospitality industry (Fig. 12). Usually quits rise during good times as people find better jobs. This time, many of the quitters may be dropping out of the labor force.

(9) Bottom line. The data do support Summers' notion that the government’s unemployment benefits were helpful at first but now may be contributing to a shortage of workers and may continue to do so under the Biden plan.

Inflation Is Up for Discussion

Inflation I: Prices Paid vs Prices Received

In recent Zoom calls with accounts, I am spending more time discussing the outlook for inflation. For investors, this may very well be among the most important, if not the most important, issue to get right in 2021 and beyond. If inflation looks likely to remain subdued, then we can “keep walking because there is nothing to see here, folks.” If inflation looks likely to make a modest comeback, then overweighting inflation hedges in portfolios would make sense. In recent months, there has certainly been some comeback-like action in the prices of assets that might benefit from higher inflation. If inflation were to make a big comeback, bond yields would soar. That could cause a credit crunch, a recession, and a bear market. I am inclined to keep walking.

Nevertheless, by popular demand, I will be returning on a regular basis to see what I can see on the inflation front.

I am counting on four deflationary forces to keep a lid on inflation. They are Détente (a.k.a. Globalization), Disruption (a.k.a. Technological Disruption), Demography (as in aging populations), and Debt (as in too much propping up zombie companies). I discussed the “4Ds” in my 2020 Fed Watching book (here is the excerpt). These forces are on one side of the tug of war over inflation. On the other side are the world’s economic policymakers. They’ve responded to the Great Virus Crisis with massive fiscal and monetary stimulus. In other words, they embraced Modern Monetary Theory. They certainly haven’t let this crisis go to waste! Let’s see what we can see in the latest price indicators:

(1) Regional prices. Five of the 12 Fed district banks conduct monthly business surveys. In addition to compiling business activity indexes, all five report prices-paid and prices-received indexes (Fig. 1). All 10 price indexes have recovered from their early-pandemic lows a year ago through January of this year. The average of the five regional prices-paid indexes is up from last year’s low of -3.6 during April to 48.4 during January, the highest since July 2018 (Fig. 2). The average of the prices-received indexes rose from -9.4 to 21.1 over this same period.

The prices-paid indexes tend to be more volatile than the prices-received indexes. That’s because the former tend to be correlated with the inflation rate of the intermediate goods Producer Price Index, or PPI (on a y/y basis), while the latter tend to be correlated with the inflation rate for the goods Consumer Price Index, or CPI (Fig. 3 and Fig. 4). Intermediate goods producer prices tend to be more volatile than consumer goods prices because they are more highly correlated with commodity prices. The spread between the averages of the regional prices-paid and prices-received indexes is highly correlated with the spread between the inflation rates of the intermediate goods PPI and the goods CPI (Fig. 5).

So what do we see? Since the start of the data in 2005, the regional price indexes have been this high before at least four times. Over that same period, the core PCED (personal consumption expenditures deflator), which is the Fed’s preferred measure of consumer price inflation, hovered just above 2.0% from 2005 through most of 2008, and has remained below 2.0% from 2009 through 2020 every month with the exception of only 14 months.

(2) M-PMI prices. January’s national survey of purchasing managers in manufacturing was released on Monday. This M-PMI survey also includes a price index, but only for prices paid. It is highly correlated with the average of the regional prices-paid indexes (Fig. 6). The M-PMI prices-paid index rebounded from last year’s low of 35.3 during April to 82.1 last month, the highest reading since April 2011. Again, this index is more reflective of commodity-related costs at the intermediate PPI level than consumer goods prices. It has been this high before a few times since 2005 without leading to a pickup in CPI inflation.

Inflation II: Commodity Prices, the Dollar, and Import Prices

The latest M-PMI report included a long list of rising commodity prices with only one down, for caustic soda. Commodities in short supply included copper, corrugated boxes, electrical components, electronic components, semiconductors, and steel. All of these are included in the intermediate goods PPI.

The core intermediate goods PPI tends to be more closely correlated with the CRB raw industrials spot price index (Fig. 7). A broader measure is the CRB all commodities price index, which includes energy and food commodities (Fig. 8). Both CRB indexes have rebounded significantly since early last year, with y/y gains of 13.7% for the broader index and 16.8% for the raw materials index.

Some of this strength in commodity prices is attributable to the 3.4% y/y drop in the trade-weighted dollar (Fig. 9). The weak dollar has certainly contributed to the rebound in the inflation rate of the nonpetroleum import price index from last year’s low of -1.1% during April to 1.8% during December. In turn, rising import prices are putting upward pressure on the intermediate goods PPI (Fig. 10).

So what do we see? The rebound in commodity prices is partly attributable to the weaker dollar, but the rebound in global economic activity has also boosted these prices. In any event, while the weak dollar and strong commodity prices are boosting import prices and the intermediate goods PPI, there’s no sign that those cost pressures are boosting consumer prices.

Inflation III: CPI Inflation Here & Over There

The core CPI inflation rate in the US was only 1.6% y/y during December. The comparable measures for the Eurozone and Japan were close to zero at 0.2% and -0.5% (Fig. 11). Over the same period, the headline CPI inflation rate in China was 0.2%, while the industrial products PPI was -0.4% (Fig. 12). We are startled by the latter given that China’s economic recovery since early last year has been so strong.

So what do we see? The same as you can see: not much inflation for consumer price inflation in the US and around the world. The rebound in commodity prices, import prices, intermediate PPI prices, and prices paid could put some upward pressure on consumer prices in the US. However, the 4Ds still have a lot of pull in the tug of war over inflation.