Inflation is Coming

THE OVERLOOK - I continue to be quite surprised with the way the market was able to overlook last week's upward revision to hourly earnings in the US jobs report. Investors were quick to dismiss the report on account of the hurricanes, and while that makes sense, it doesn't make sense when it comes to data that wasn't impacted by the storm. The upward revision to hourly earnings that predated the hurricanes was a big deal in my view and hasn't registered with investors. It could be argued that the market recognized the revision and didn't react simply because it doesn't believe it will change the outlook as far as lower for longer monetary policy goes. But that's a dangerous assumption to be making at this stage in the game.

THE THREAT - The biggest ally to the stock market over the past several years has been low interest rates. Rates at record lows have been the low hanging fruit that's made the exercise of making money on the long side of stocks as seamless as breathing. And while it's true that the end of low rates and the onset of policy normalization are not necessarily enemies of stocks right now, with policy normalization expected to happen at a super slow speed, it's also true that there is another variable out there that could prove to be a more imminent threat to the stock market. And that variable is inflation. Indeed, the Fed itself has been perplexed at the way inflation has remained subdued and has failed to shoot up despite the implementation of unprecedented policy accommodation. But that doesn't mean the Fed doesn't think inflation is coming.

GRAIN OF SALT - Yellen has warned repeatedly that she expects inflation to shoot up and has gone even further to add that when it does shoot up, it's going to happen real fast. And so, going back to last week's hourly earnings revision, it kind of makes you think. Again, the stock market run has been staggering and the only legitimate argument for an even higher market (as far as I'm concerned) is that the Fed model isn't showing stocks as overvalued. This is because the Fed model looks at stocks relative to interest rates, and using that barometer, of course stocks aren't overvalued. We're talking about free money out there and a massive experiment to stimulate the global economy through radical policy accommodation. So when the Fed Chair says stocks aren't overvalued considering where rates are, you need to take the comment with a grain of salt.

THE DANGER - All of this brings us back to the central point. While a reversal of policy may not be an enemy to stocks, inflation is definitely an enemy. The market hasn't worried about this enemy up until now, but when you start seeing inflationary metrics like hourly earnings tick up, you need to take notice. That revision should be a bigger worry than it has been and the fact that the market has barely reacted to it is shocking! If inflation shoots up out of nowhere, the Fed WILL NOT have the luxury of raising rates as slowly as it wants to. AND THAT'S A BIG DEAL! Policy normalization already isn't great for stocks and while it isn't an enemy per se, the combination of policy normalization and rising inflation will be a dangerous recipe with brutal consequences. Inflation is coming.