June 3, 2013
Several months ago we presented a dramatic change in David Rosenberg’s outlook when from a die hard deflationist, he uttered the first rumblings of an inflationista. Since then he has further focused his substantial shift in perception culminating with this: “The number of firings, in fact, are more than 10% lower today with a 7.5% unemployment rate than they were in May 2007 when the unemployment rate had hit its cycle trough of 4.4%. Right there that tells you that 7.5% is the “new 4.4%”. Yikes. Sounds very 1970s-ish — and recall in that decade, real spending growth was weak but the supply curve was so sclerotic that inflation stayed stubbornly high. At the same time, at a time when firings are at record lows and job openings are rising at a double-digit annual rate, the number of people quitting their current job for greener pastures elsewhere is on a discernible uptrend. All this points to higher wage growth ahead, and frankly, this is a good thing for society.” Of course, Rosie is simply picking up on what we discussed over a year ago: namely that courtesy of central planning, Okun’s law is now terminally broken.
It also means that higher wages for those workers who are in demand (and perpetual part-time status for those who aren’t) will lead to another unpleasant side effect for those forecasting soaring EPS for the S&P: a further drop in corporate margins, which as we keep on showing are now the lowest they have been in over two years: “But the flip side is that as the labour share of the national income pie mean reverts off its all-time lows, we are likely to see profit margins pinched. This is the big risk: margin compression affects the ‘E’, while inflation, insofar as the tight historical relationship with final prices holds, even if to a smaller degree this time around, affects the P/E.”
Some claim to see this in the chart of the Labor Share of income, which to the delight of Marxists everywhere, may have finally broken its long term downtrend and found a support level:
But wrapping it all together, there is one word for what follows: stagflation.
The next major theme is stagflation — this will be the legacy of the Bernanke regime. You cannot keep real short-term rates negative for this long in the face of even modestly positive real economic growth without generating financial excesses today and inflationary pressures in the future. Imagine dusting off the Phillips Curve and getting away with it — it’s as if the Fed has changed religions as it now believes there is some trade-off between inflation and unemployment The last time we had negative real policy rates for this long with a central bank wedded to the Phillips Curve was under the Burns-led Fed of the early 1970s. As I have said recently — I am undergoing my own epiphany. I am renowned for being very early — to a fault — in my calls and no doubt am early yet again.
Little by little all the deflationists are starting to fold.