Two items for “Data” today:
#1: Q3 US GDP was better than the Atlanta Fed’s GDPNow model (+2.0 pct actual, 0.2 pct expected), which is a relief; we were curious, however, as to how M2 Money Velocity looked in the most recent quarter. As you can see from the chart below (1960 – present), money velocity (GDP/money in the system) remains low. Extremely low, in fact, at 1.12x as compared to either 2019 (1.4x) let alone the peaks of +2.0x in 1997.
Takeaway: money doesn’t create lasting goods and services inflation unless it is incrementally spent on, well, goods and services. There is little evidence that this is occurring; Q3 2021’s money velocity was slightly lower than a year ago and there’s been no improvement for 3 quarters. We are a long way, both in direction and level, from the 1.7x to 1.9x ramp in US money velocity that coincided with peak inflation in 1980.
#2: As bullish as we are on US stocks, we spend much more time worrying about what could go wrong in the not-too-distant future than cheerleading new highs. Maybe it comes from sitting next to too many grumpy traders over the years and endlessly hearing “Sell when you can, not when you have to …”.
Regardless of the reason, here are 3 things that keep us up at night:
First: will high levels of US labor force turnover (as JOLTS shows monthly) combined with increasing levels of remote/hybrid work (evidenced by still low office occupancy) structurally damage America’s labor productivity? There’s only two factors that define how sustainably an economy can grow across economic cycles: more people in the workforce and more productivity from those workers. That’s it.
Current high levels of turnover can’t be helping productivity; most workers need many months or even years with an organization to learn the ropes and contribute. And while there is limited work as of yet on how remote/hybrid work is affecting productivity, what there is says only the very best-run businesses are seeing gains.
If American businesses lose a point of productivity growth every year for the next 5 years due to these factors, that is one less point of GDP growth everything else equal. And, as the Q3 report showed us today, the American economy needs every point of growth it can get.
Second: when do Wall Street earnings estimates finally catch up to reality? Every Sunday night we show you how analysts are too low on their Q3 and Q4 estimates, just based on Q2 actual earnings power. Our own guesstimate for 2022 earnings is $233/share; that is 10 percent higher than current earnings power of $212/share. The Street is at $221/share, so we have some ways to go. After that, however, we (and everyone else) will really have to sharpen the pencils on where 2023 earnings will end up. That will be a lot harder than calling the earnings beats over the last year.
Third: when will US inflation matter to markets and policymakers? CPI running +5 percent over the last 4 months has 1) not done much to 10-year yields (below 1.6 pct), 2) only recently nudged higher Fed Funds Futures odds of 2022 rate increases, and 3) only taken 5-year inflation expectations in TIPS to 2.9 percent.
We know exactly why markets are unimpressed by the recent +5 percent inflation prints: because the history since 1985 says they never last. The chart below shows headline CPI from then to now. We’ve drawn a line at 5 percent and noted every time inflation has crossed that level. The total is 9 months (7 during the oil price spike around Gulf War I, 2 in the 2008 speculative bubble). We are at 4 and counting now. Yes, CPI inflation was +5 percent from 1973 to 1982. But the market does not think we are in that sort of environment yet. Rather, it is looking at the post-1985 experience and thinking history will repeat itself. That paradigm works for now, but you can see why we worry about this issue. It works until it doesn’t.