Friday, April 9, 2021

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.

Monday, March 29, 2021

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

Thursday, March 11, 2021

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!

Friday, March 5, 2021

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.

Sunday, February 21, 2021

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).

Wednesday, February 10, 2021

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.

Wednesday, February 3, 2021

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 D├ętente (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.

Saturday, January 16, 2021

Party Like There's No Tomorrow!

After listening to the lyrics of “Party Like There’s No Tomorrow,” I think it might be a more fitting theme song for our current milieu than “Party Like It’s 1999.” The former was released in 2008 by an acid-rock band while the latter was released during 1982 by the rock star Prince. The former starts with: “Tonight we’re gonna party like there's no tomorrow / Forget about our woes and drown our sorrows.” The rest of the song is sprinkled with lots of expletives belted out by the nutty band.

While tomorrow will undoubtedly occur on schedule, the Covid-19 pandemic is raging like never before. Yet investors are partying with abandon: The S&P 500 and Nasdaq continue their meltups in record-high territory. On Friday, January 8, they were up 70.9% and 92.4%, respectively, from their March 23, 2020 lows. Previously, I have observed that these two widely followed stock indexes soared 59.6% and 236.7% from their LTCM-crisis lows on August 31, 1998 through their blowoff tops in March 2000—so the Prince song came to mind (Fig. 1 and Fig. 2).

The S&P 500 forward P/E rose to a record 25.7 during the week of July 16, 1999 (Fig. 3). It rose to 22.9 on Friday, January 8. The forward P/E of the S&P 500 Technology sector peaked at an all-time record high of 48.3 during March 2000. It was up to 27.7 on Friday, January 8.

I am still targeting the S&P 500 to rise to 4300 by the end of this year (up 14.5% y/y) and 4800 by the end of 2022 (up 11.6% y/y). I am increasingly concerned that the market could get to those levels much sooner, leaving valuation multiples even more stretched than they are today. That would make the stock market increasingly vulnerable to a meltdown. In any event, the bull market stampede has been trampling not only the bears but also even bulls like me since March 23, 2020!

While today’s multiples can be justified by near-record low bond yields, the 10-year US Treasury yield has been trending higher since it bottomed at a record-low 0.52% on August 4 last year (Fig. 4). Here are the new year’s firsts: First thing during the morning of the very first trading day of the new year, the yield rose just above 1.00% for the first time since March 19. It rose to 1.13% on Friday, January 8. The ratio of the price of copper to the price of gold suggests that the bond yield should be closer to 2.00% than to 1.00% (Fig. 5). It certainly seems headed in that direction so far this year.

Now, as in 1999, there are mounting signs of irrational exuberance in the stock market. This time, there are also more signs of ultra-stimulative fiscal and monetary policies than there were back then. The combination could be fueling MAMU—the Mother of All Meltups. Consider the following:

(1) The Blue Wave is coming. Now that the Democrats have control of the White House and both chambers of Congress for at least the next two years (until the mid-term elections), federal government spending is likely to continue growing faster than federal revenues, even if taxes are raised on upper-income taxpayers and on corporations (Fig. 6). The resulting increase in federal debt could be nutty.

The Democrats plan on sending another round of stimulus checks to households. The next package of support is bound to also include hundreds of billions of dollars to bolster the finances of state and local governments. The Biden administration is expected to use early legislation to push hundreds of billions of dollars in renewable energy spending as part of its stimulus and infrastructure measures, potentially including efforts to promote the construction of high-speed rail, 500,000 electric vehicle charging stations, and 1.5 million energy-efficient homes. In the fiscal follies, a billion here, a billion there can add up to trillions very rapidly. (We first discussed the incoming administration's agenda in our July 21, 2020 Morning Briefing titled “Meet the New, Improved Joe Biden.")

(2) The Bond Vigilantes are stirring. While the bond yield was higher in 1999 than it is today, the federal budget was actually in surplus back then (Fig. 7). Over the past 12 months through November, the budget deficit was a record $3.2 trillion. The Fed has helped to keep bond yields down by purchasing $2.4 trillion in Treasury securities over the 12 months through December (Fig. 8).

Those purchases have been concentrated in the longer end of the yield curve more so than in the past (Fig. 9 and Fig. 10). That certainly explains why the bond yield remained below 1.00% during the second half of 2020 even as the economy staged a V-shaped recovery.

However, the Bond Vigilantes are starting to stir. If they succeed in pushing yields higher, stock investors might have second thoughts about the nutty idea that even higher equity valuations are justified. Then again, I can’t rule out the possibility that the Fed would do something nutty like officially adopt a policy of yield-curve targeting to keep a lid on the bond yield. The Bank of Japan’s monetary madness has included doing that since September 2016. If the Fed started to officially target the bond yield, the result would almost certainly be a 1999-style meltup.

(3) The virus is mutating. What could possibly go wrong, causing the meltup to be followed by a meltdown? In my forthcoming book, The Fed and the Great Virus Crisis, my central theme is don’t fight the Fed when it is fighting a pandemic. That worked well in 2020. In 2021, investors need to have the vaccines win the world war against the virus (WWV) and its mutant variants.

While we humans have been celebrating the end of 2020’s annus horribilis, anticipating that 2021 will be a better year for humankind, the virus couldn’t care less. It continues to party like its 1919, which was the second year of the much deadlier Spanish flu pandemic. The near-term outlook on the health front is discouraging, but hopefully the tide of WWV will change meaningfully in our favor in coming months as more of us get inoculated.

Sunday, January 10, 2021

Blue Wave Makes a Splash in DC. Will Joe Manchin Be 'Senator Gridlock'?

The Blue Wave made a big splash as Tuesday’s Georgia election results, reported late Wednesday afternoon, showed that both of the state’s seats for the US Senate were won by the two Democratic candidates. A tsunami of socialist policies implemented by progressives in the Democratic party is now likely. A Blue Wave led by the incoming Biden administration, unimpeded by gridlock, certainly represents a radical regime change from the Trump administration. It is likely to be much more radical than the regime change led by the Obama administration. That’s because the Democrats in Congress are much more radical in their left-leaning political views than ever before.

The Democrats’ win in Georgia could be bad news for entrepreneurial capitalism. It could also be bearish for the stock market if the radical regime change causes a recession. That’s unlikely to be the case in 2021. Granted, the 10-year US Treasury bond yield pushed above 1.00% at the start of the week on preliminary news that the Republicans lost one of the two contested elections. I previously argued, even before last year’s elections, that the yield would be closer to 2.00% than 1.00% but for the Fed’s intervention in the bond market.

My analysis was based on the strong post-lockdown rebound in economic activity and the swelling post-CARES Act federal budget deficit rather than on a prediction of a regime change in Washington, DC. Now that the Blue Wave has prevailed, government spending will continue to boost economic activity, and federal deficits will continue to mount. And, most importantly, the Fed is likely to continue to buy notes and bonds in an effort to keep bond yields from rising too rapidly.

In other words, the Fed is likely to enable our deficit-financed government to get bigger under the Blue Wave regime. The Clinton administration was famously checked and balanced by the Bond Vigilantes. The Fed is implicitly assuring the incoming Biden administration that monetary policy will keep them buried as much as possible.

Now consider the following related observations about the stock market:

(1) Socialism isn’t necessarily bearish. Significant declines in stock prices are caused by recessions, not by socialist regime changes, unless they are so radical that they cause a recession. Socialism may be bad for entrepreneurial capitalism, but it provides fertile ground for crony capitalism. That’s as long as it doesn’t lead to communism. Under socialism, private property remains mostly private. Under communism, there is no private property; everything is owned by the state. In either system, the government gets bigger. Under socialism, the ruling regime enacts more laws and regulations that force businesses to manage their affairs increasingly to satisfy their socialist overseers rather than their capitalist shareholders.

(2) Betting on crony capitalists. In other words, making deals with the government matters as much as or more than competing in the market. That’s the fundamental nature of crony capitalism. Businesses become bigger and more politicized as the government gets bigger and more radicalized.

That’s not necessarily bearish for the stock market. However, it does mean that assessing the impact of government policymaking on business becomes as important or more important than traditional analysis of company fundamentals. Spreadsheets for individual corporations need to include columns for the number of lobbyists employed, percentage of business done with the government, cost of regulation, and so on.

(3) And the winner is ... Previously, in my November 2, 2020 LinkedIn newsletter titled “Gridlock Is More Bullish Than Blue or Red Waves,” I observed that gridlock tends to be more bullish for stocks than a united government. I analyzed the performance of the S&P 500 under unified and divided government since FDR took office (Fig. 1). I calculated the percentage increases in the index from January-through-December periods during the two alternative regimes. I found that during the previous six Blue Waves, the S&P 500 increased 56% on average. During the previous three Red Waves, the index rose 35% on average. During the seven periods of divided government, the S&P 500 rose 60% on average. This suggests that gridlock is more bullish than the two unified alternatives, which are also bullish, but less so, with Blue Waves more bullish than Red Waves.

So not surprisingly, on Monday, stock prices fell because the Blue Wave is coming. Yet on Wednesday, they rose because the Blue Wave is even more likely to come! Go figure. While gridlock was the loser in Georgia’s elections on Tuesday, the winner will surely be $2,000 stimulus checks. That's probably bullish for the economy and the stock market during the first half of 2021.

(4) Meet the other Joe, again. Perhaps investors figure Senator Joe Manchin (D-WV) will defend gridlock to the death. We first introduced him to our subscribers in our November 16 Morning Briefing. We wrote: “If the Democrats pull an upset and get both seats, Joe Manchin could be the most important person in America. He is the Democratic senator from West Virginia. He is viewed as a conservative Democrat and has championed bipartisanship.

On Monday, November 9, Joe Manchin was interviewed by Fox News. He said: “50-50 [control] means that if one senator does not vote on the Democratic side, there is no tie and there is no bill.’ He added: ‘I commit to tonight and I commit to all of your viewers and everyone else that’s watching, I want to allay those fears, I want to rest those fears for you right now because when they talk about, whether it be packing the courts or ending the filibuster, I will not vote to do that.’

“He continued saying that the ‘Green New Deal’ and ‘all this socialism’ was ‘not who we are as a Democratic Party.’ He remarked: ‘We’ve been tagged if you’ve got a D by your name, you must be for all the crazy stuff and I’m not.’”