Joe Zidle: Winds of Inflation Rising
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When the number of people filing for first-time unemployment hit a level not seen since 1969—when Jimi Hendrix and Janis Joplin headlined Woodstock—you know labor markets are tight. The very distance in time may be one reason many investors have yet to recognize or react to this clear inflationary sign. Or perhaps they believe that the relationship between low unemployment and wage inflation is broken; a dangerous assumption given the massive inflows into fixed income and the proliferation of dividend-yielding strategies—both of which would suffer mightily in an inflationary context.
Wages, bonuses and incentives will need to increase further Our private equity group owns over 90 portfolio companies, which together employed over 460,000 people as of June 30, 2018. The ability to retain qualified workers ranks as one of our portfolio company CEOs’ biggest concerns according to a Blackstone survey. Over 60% of our CEOs believe pay will need to increase 3% or more in 2018, ahead of government figures.
Higher pay isn’t enough to keep them The number of people quitting relative to getting fired hit an all-time high this month (chart below). The primary reason why people quit their job in large numbers is because they have something better lined up. Some of the cost will be passed along to consumers, the rest will be absorbed.
More People Quitting vs. Getting Fired Than Ever
Source: Blackstone, Bureau of Labor Statistics
Word count in the Fed’s Beige Book Inflation isn’t just limited to wages. Oil & gas markets, bottlenecks in supply chains and now tariffs are threatening to upend prices from all sides. The recently released Fed Beige Book contains anecdotes from companies on the front lines of changes on these macro trends. In the July release, the word “inflation” appeared 15 times. The previous 5 years show an average of only 6 “inflation” references (see chart below) in the report. Companies are telling us about inflationary pressures at a rate well above that in recent years.
# of instances of Inflation appearing in the Beige Book
Source: Federal Reserve, Blackstone
Long-term underperformance Inflation this time around may be more persistent, and pernicious. In addition to recent acceleration in economic growth, clear labor shortages and pricing pressure, there’s interest rate risk emerging from the mismatch between greater deficits and shrinking Central Bank balance sheets. With the 10-Year Treasury note anchored at 2.85% and inflation on the rise, investors could be making a big bet against higher interest rates.
Taken together, the low rate environment has changed Bonds don’t do well when inflation accelerates. Nor do dividend-yielding strategies or other low-beta defensive positions. Year to date the Bloomberg Barclays Aggregate Bond Index is negative; the MSCI US High Dividend Yield Index is up about 1%, but well behind the 6% return for the S&P 500. We suggest investors keep watch for changes in the weather.
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