A dovish Fed and weaker dollar could create space for both wages and profits to rise.
I was invited onto Bloomberg Television recently to talk about my outlook on equity markets, the path for Fed rate hikes, and the U.S. consumer and retail sector.
It’s interesting to think about how those three subjects relate to one another. The missing link? It might be productivity.
Wages, Prices and Profits
Last week the latest Global Economic Outlook from The Conference Board projected a fall in U.S. GDP per hour worked of 0.2% this year. That would mark the first year-over-year decline since 1982.
With low productivity growth as the background, it’s extremely difficult to sustain a mix of wage growth, modest inflation and accelerating corporate earnings. Two of the three would seem possible, but not all of them, and since mid-2014 the choice the market has made has been obvious: We’ve had an earnings recession with rising wages, alongside steady, low inflation.
I warned against chasing this market over a month ago, and since then it has crept up to a multiple of around 17 times 2016 projected earnings.
On the face of things, it’s not obvious those earnings will materialize. When productivity was growing, rising wages led to more demand, which enabled price increases, wider margins and modest inflation. Today, global competition and a strong dollar have eroded corporate pricing power, leaving us with rising wages, subdued inflation and meager earnings.
Industry Is Struggling Despite High Consumer Confidence
This dynamic helps explain how we got such a disappointing reading from the Richmond Fed manufacturing index last week, at the same time as we got the biggest monthly rise in new home sales in 24 years. These are just the latest in a series of data points drawing a stark contrast between the moods of U.S. industry (which worries about the strong dollar, cheap oil and falling profits) and U.S. consumers (who wield a strong currency to buy cheaper gasoline and stuff to furnish their new homes). Significant shifts in consumption patterns—more online rather than high-street shopping, more purchases of experiences over goods—amplify this dynamic.
If earnings are to recover, either wage growth must slow or inflation, in the form of companies’ pricing power, must take hold. Regular readers may guess where our bias lies. Last week, Brad Tank outlined his expectations for a range-trading dollar and for a while we’ve said that a flat-to-weaker dollar and a firmer oil price were a foundation for earnings recovery. Both would stoke inflation, too.
And that is where the Fed comes in. A dovish second half of 2016 would cement this subdued-dollar, higher-inflation theme.
Recent “Fed speak” does little to support the thesis, apparently softening us up for more than one hike this year. Markets put the probability of a June hike at around 30%, but that’s up from 4% just a couple of weeks ago. The fact that risk assets have taken this in their stride, bank stocks have rallied and gold has sold off might embolden the FOMC.
How ‘Political’ Will the Fed Be?
The consensus on our teams is indeed for two hikes, not beginning in June, but at the September and December meetings. Why not in June? Because we’ll still be waiting on the Q2 GDP print and, lest we forget, the Q1 numbers were very disappointing. Furthermore, the June meeting comes just before the U.K.’s referendum on EU membership—which both the dovish Bill Dudley and the hawkish Robert Kaplan have cited as a reason to hold fire.
It is the question of how “political” the Fed might be that makes me err on the side of fewer rate hikes than some of my colleagues. Without a press conference in July and August, the FOMC risks hiking without being able to shape the message. Then we’re past Labor Day and deep into the clamor of the general election, during which you’d forgive the central bank for sitting on the sidelines.
With these sensitivities to consider, I would not be surprised to have to wait until December for the next hike. That could take some wind out of the dollar’s sails, underpin the ongoing recovery in inflation—and, potentially, free up margins to rise along with wages and place a cushion under today’s equity market multiples.
In Case You Missed It
- U.S. New Home Sales: +16.6% to SAAR of 619,000 units in April
- U.S. Durable Goods Orders: +3.4% in April (excluding transportation, durable goods orders increased 0.4%)
- U.S. 1Q 2016 GDP (second estimate): +0.8% annualized rate
What to Watch For
- Tuesday 5/31: U.S. Personal Income and Outlays
- Tuesday 5/31: Case-Shiller Home Prices
- Tuesday 5/31: U.S. Consumer Confidence
- Wednesday 6/1: Global Purchasing Manager Indices
- Wednesday 6/1: ISM Manufacturing Index
- Thursday 6/2: European Central Bank Policy Meeting
- Friday 6/3: U.S. Employment Report
- Friday 6/3: ISM Non-Manufacturing Index
– Justin Gaines, Investment Strategy Group
Statistics on the Current State of the Market – as of May 27, 2016
|
Market Index |
WTD |
MTD |
YTD |
|
Equity |
|||
|
S&P 500 Index |
2.3% |
1.9% |
3.7% |
|
Russell 1000 Index |
2.3% |
1.8% |
3.6% |
|
Russell 1000 Growth Index |
2.4% |
2.0% |
1.8% |
|
Russell 1000 Value Index |
2.2% |
1.7% |
5.5% |
|
Russell 2000 Index |
3.5% |
1.9% |
1.9% |
|
MSCI World Index |
2.3% |
0.7% |
2.2% |
|
MSCI EAFE Index |
2.2% |
-0.7% |
-0.7% |
|
MSCI Emerging Markets Index |
3.0% |
-3.6% |
2.5% |
|
STOXX Europe 600 |
2.8% |
0.2% |
-0.2% |
|
FTSE 100 Index |
1.9% |
0.9% |
2.5% |
|
TOPIX |
0.5% |
0.7% |
-11.9% |
|
CSI 300 Index |
-0.5% |
-2.8% |
-17.7% |
|
Cash & Fixed Income |
|||
|
Citigroup 2-Year Treasury Index |
0.0% |
-0.2% |
0.7% |
|
Citigroup 10-Year Treasury Index |
0.2% |
-0.2% |
4.4% |
|
Barclays Municipal Bond Index |
-0.2% |
0.2% |
2.6% |
|
Barclays US Aggregate Index |
0.2% |
0.0% |
3.4% |
|
Barclays Global Aggregate Index |
0.2% |
-1.2% |
6.1% |
|
S&P/LSTA U.S. Leveraged Loan 100 Index |
0.4% |
0.5% |
5.5% |
|
BofA Merrill Lynch U.S. High Yield Index |
0.8% |
0.6% |
8.0% |
|
BofA Merrill Lynch Global High Yield Index |
0.6% |
-0.1% |
7.6% |
|
JP Morgan EMBI Global Diversified Index |
0.3% |
-0.2% |
6.7% |
|
JP Morgan GBI-EM Global Diversified Index |
0.0% |
-5.3% |
7.9% |
|
U.S. Dollar per British Pounds |
0.7% |
-0.2% |
-0.8% |
|
U.S. Dollar per Euro |
-0.7% |
-2.8% |
2.5% |
|
U.S. Dollar per Japanese Yen |
0.5% |
-2.6% |
9.5% |
|
Real & Alternative Assets |
|||
|
Alerian MLP Index |
-1.1% |
2.2% |
8.8% |
|
FTSE EPRA/NAREIT North America Index |
1.7% |
1.9% |
5.8% |
|
FTSE EPRA/NAREIT Global Index |
1.5% |
-0.5% |
4.8% |
|
Bloomberg Commodity Index |
0.7% |
0.0% |
8.9% |
|
Gold (NYM $/ozt) Continuous Future |
-3.1% |
-5.9% |
14.5% |
|
Crude Oil (NYM $/bbl) Continuous Future |
1.9% |
7.4% |
33.2% |
Source: Factset, Neuberger Berman LLC.
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