Growth vs. Inflation

Major stock market averages fell at the open (Dow -225 pts; SPX -.5%). Financials and consumer discretionary sectors are down more than 1% in early trading. The more traditionally defensive sectors—consumer staples, utilities, real estate—are holding on to modest gains. Commodities are mixed today. Oil is falling  back a bit to $/barrel. Copper is down 1% but gold is up about .2%. The bond market has been in rally mode over the last week. Higher bond prices push interest yields lower. The 10-year Treasury Note, considered a key risk-free interest rate in the economy, has fallen back to 1.42%. My sense is that investors are struggling to figure out what the bond market is signaling. It’s easy to say lower rates signal lower economic growth expectations, but massive fiscal and monetary stimulus, as well as near-zero or negative yields in Europe & Japan have really distorted interest rates.

Last Friday’s jobs report from the Bureau of Labor Statistics set the tone for a mini-rally. The tally of net new payroll positions across the country soared 531,000 in October compared with economists’ consensus forecast of 450,000. September payrolls were also upwardly revised from initial estimates. As enhanced state unemployment benefits expired and Covid Delta receded, more people went looking for jobs. This pushed the unemployment rate down to 4.6%, and the under-employment rate down to 8.3%. According to the report, wage growth accelerated to 4.9% from year-ago levels, which is a pretty big jump although not quite enough to fully offset inflation. If there is any bad news in the report, it is that the labor force participation rate didn’t budge from 61.6%. Pre-Covid, we were over 63%. The nation is still 4 million jobs short of pre-pandemic levels, but a segment of the population doesn’t seem to want to return to work yet. Nevertheless, the takeaway for investors is clear: the job market and economy are strong enough to warrant removal of Federal Reserve stimulus.

Today we learned that wholesale inflation—as measured by the Producer Price Index (PPI)—accelerated to 8.6% in October, the highest rate since 2010. Of course, some of that can be explained by the recent surge in oil prices; PPI excluding food & energy was up 6.8%. The lion’s share of wholesale inflation is due to a very sharp increase in goods rather than services prices. And companies are generally passing along these costs to consumers. For example, McDonald’s just raised prices by 6%. Shark Tank host and business owner Kevin O’Leary says half of the inflation we’re seeing is temporary, and the other half is likely to be persistent. He says US companies can’t get product from Asia and are turning to domestic producers with higher prices. But “when we get the supply chain issue resolved and we can source from our original sources,  we will bring that back to where our original costs were.”

About 450 of the S&P 500 companies have reported third quarter results and the verdict is positive. In aggregate, nearly 68% beat Wall Street revenue forecasts and 81% beat profit expectations. Corporate America is doing an excellent job rebounding from the Covid Crisis despite dealing with supply chain disruptions and delays. Certainly these mostly positive announcements helped the stock market recover from September’s correction. But what now? As Bloomberg News notes, “Global equities are hovering near all-time highs as investors weight strong earnings, easing travel curbs and US infrastructure spending against the risk of persistent inflation that may lead to tighter monetary policy.” This growth vs. inflation tug-o-war is the market’s biggest debate at present.