What Did We Learn This Week? (08/11)—Secular vs. Cyclical

Tim Pierotti, Chief Investment Strategist

Secular vs. Cyclical 08/11/2022

Equity markets have put in yet another euphoric week driven by a CPI print that came in cooler than expected. Fed speak is downright pleading with the market to not to get too far ahead of itself, but their hawkish and coordinated statements have been entirely ignored. The prevailing market narrative seems to be that the US economy will continue to plod along at the current Real GDP of 0 to 1% which will be adequate to bring down inflation to a glidepath toward the Fed’s 2% target allowing the Fed to revert to cutting rates some time next year. We disagree with that narrative mainly on the basis that we see the inflation problem as more secular than cyclical, but also because we think the Fed has more resolve to combat a potential “wage price spiral”.

In case you missed it, allow me to quote some of the commentary from the various Fed members this week.

Minneapolis Fed President Kashkari: “In June, in the Summary of Economic Projections, where all the FOMC participants put in their own projections of interest rates for the next few years, I recommended being at 3.9% by the end of this year, and 4.4% by the end of the following year. I haven’t seen anything that changes that”

San Francisco Fed President Daly commented that the committee was, “nowhere near almost done”. When asked about fixed income markets discounting cuts next year, she replied, “That’s a puzzle to me. I don’t know where they find that in the data.”

Chicago Fed President Evans: “I expect that we will be increasing rates the rest of this year and into next year to make sure inflation gets back to our 2% objective.” Evans went on to say that he expects rates to end 2023 at 3.75% to 4%.

So, we have Fed speakers telling the market that they see Fed Funds at 4% or even more at the end of 2023 and yet as of this writing, we are looking at the 2yr below 3.25%. In the end, the market simply doesn’t yet buy the argument that we are in a new inflation regime and after forty years of falling inflation, I understand the reluctance, but our call remains the same. Inflationary pressures are structural and driven by aging demographics, deglobalization and falling legal immigration. All are former tailwinds and now they are all headwinds.

One of the main components that drove the more benign CPI print was a month over month decline in airfares, which I find particularly ironic given that the air travel space exemplifies long term structural labor force issues . Have look at some of the headlines for just the last couple weeks:

“Airline worker shortage causing massive backup with luggage”

“Orlando airport workers continue their fight for fair wages, benefits and dignity on the job”

“Pilot shortage prompts proposals to raise retirement age”

“Airline asked its senior executives to temporarily help as airport baggage handlers”

“Labor shortage causing airlines to over-hire workers”

Are these the kind of headlines you would expect to see in an industry likely to experience disinflationary pricing? The pandemic served to pull forward the dynamic the airlines and other industries are now dealing with and that is a shortage of workers and the challenging productivity ramp of training new workers replacing all those 55 and older workers who have chosen to not return to the workforce. Labor force participation rates continue to disappoint suggesting the tightness in the labor market is far from transitory.

Tim Pierotti is WealthVest’s Chief Investment Strategist. 

Tim has over 25 years of experience in various aspects of the equities business. Prior to joining WealthVest, Mr. Pierotti spent seven years in Equity Research management roles at Deutsche Bank and most recently at BMO where he was a Managing Director and Head of US Product Management. Tim has 11 years of investment experience most notably as Head of Consumer Research and Portfolio Manager at The Galleon Group, a former NY based $8Bln Long/Short hedge fund. Tim is a graduate of Boston College and lives in Summit NJ.

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