Saturday, March 17, 2018

We Still Think the Market's a Bit Behind the Inflation Curve

On balance, last week's economic data releases were decent; better than decent when we look at consumer confidence, jobs-related data and industrial production. We're seeing virtually no signs presently of any heightened risk of a near-term recession; which is of course what we're forever on the watch for as we consider our equity exposures.

A quick note on the industrial production results. The strong manufacturing number (+1.2% month over month) offered more evidence (strength in business equipment) that businesses are indeed in expansion mode; we touched on this briefly last weekend. This is particularly good news in terms of inflation.

Speaking of inflation, our analysis, as we've been discussing herein, suggests that the present risk is a bit higher than the financial markets seem to be pricing in. And last week's data has us by and large sticking to that view:

  • The Job Openings and Labor Turnover Survey (JOLTS) shows 400,000+ more job openings than the highest economist' estimate. Suggesting that employers are having a tough time attracting candidates. Filling those positions might require bigger carrots (higher employment costs).
  • The NFIB small business survey for February confirms the first bullet point: Respondents are reporting that finding qualified workers is presently their number one challenge, and 31% report that they're increasing wages and other compensation going forward (that's the highest rate in the past 18 years).
  • Friday's release of March consumer sentiment (a 14-yr high btw) had inflation expectations among respondents rising from 2.7% the previous month to 2.9% currently. This is something the Fed pays close attention to.
  • Both the Empire State and Philadelphia Fed manufacturing survey respondents see their selling prices rising sharply in the months ahead.
  • The factory capacity utilization rate rose to 78.1%, which was beyond the highest range of economist' estimates. Prices rise as companies push the limits of their capacity to produce. 78.1% is not a scary number, but we're at this point talking trend...
So, back to the strong business equipment manufacturing number; that's good news as the resulting gains in productivity should serve to somewhat quell the rate of inflation going forward.

However, as we keep saying, while we aren't nearly predicting runaway inflation, we think it's coming a bit faster than markets are presently discounting. Not a bad thing at this stage of the cycle -- oh, and by the way, a quickening of the pace of business investment is generally a mid-cycle phenomenon -- but it portends higher equity market volatility going forward.

The Fed meets this coming week; we'll see if they see inflation's prospects the way we do. If so, and if their language reflects it, look for some more of that volatility we keep talking about...

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