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Labour's Day


Wages are growing with unemployment at record lows but inflation is declining. Pricing weakness is persistent in the modern disruption economy. So, who's going to take the hit? CEOs should be worried.

Most economic models will tell you that we should have seen some serious acceleration of inflation by now. The FED, in another blow to its credibility, has been overestimating inflation projections for the past ten years. What is going on?

Technology driven deflation is mostly to blame. And you can throw in demographics and globalization for good measure. Get used to it. Corporate profit margins are peaking. Companies have less pricing power in this cycle than ever before.

Wages: Average Hourly Earnings

CPI

It's labour's turn to benefit from the very long expansion that has occurred. The capital spending that will be necessary to generate the productivity gains is evident in the tech sector's consistent equity market leadership. There is no boom coming from the traditional drivers of the old economy, autos and housing. Those are spent forces, given stretched personal balance sheets and affordability issues. But there is no bust either, with such an easy financial conditions backdrop, courtesy of the patient FED.

We can expect a slower economy, but increasingly the soft landing scenario is being embraced by market watchers. That means tight labour markets will persist for the near future. So it is left to the corporate sector to absorb this cost creep. They have two choices, lower profits and/or improved productivity. Naturally the former is not a pleasant thought so it looks like they will use technology to keep the higher wage bill from biting. We shall see how successful companies are over the next three quarters at absorbing wage hikes. I for one am not optimistic.

China's PMI last night, and the weaker Chicago PMI report this morning are wake up calls for the persistence of economic weakness. The monetary and tax stimulus that got the Shanghai markets up 35% in three months will not be repeatable. The Chinese markets got well over their skis and the pull-back has begun. Having 'priced in' a successful trade deal, the elevated emerging markets are now vulnerable to profit taking.

Market insurance is cheap but should we care? Despite all the market's worries, volatility has collapsed yet again. The 'short-vol' trade has been re-energized and hedge funds are scrambling to play. Unfortunately the flows into protection trades are also at an extreme. The retail trade has been to go long vol, and the hedgies have taken the other side. (Charts are from Tyler Durden writing in Zero Hedge).

VIX Futures Positioning

VIX ETP Flows

So toss a coin on that one. Somebody is going to be really happy next month. I'm just not sure I know who it is.

I'm concerned that the positive narrative of a soft landing will shortly be replaced by a profits recession. The current earnings parade, has not been as bad as feared. Google earnings have been the biggest negative surprise and Apple is expected to report weak numbers. Facebook and Microsoft beat estimates, making the reporting season a bit of a wash.

Banks have gotten a bid lately, but I think that is reflecting a weak catch-up trade. When in doubt, buy cheap banks.

The 2018 panic over global growth that stemmed from FED tightening fears has now been forgotten. The current earnings are looking good compared to the overly pessimistic estimates generated by the Q4 swoon. The 2020 fears, whatever they might turn out to be, are well over the horizon. A dangerous complacency has now descended on the markets.

The cyclical upswing from China stimulus has failed to boost to commodities after the dollar index made new highs. Agriculture has taken most of the pain, but the industrial metals have also cooled. I am a structural bull on this asset class, but the momentum is fading on the seasonal trade.

Energy feels propped up by artificial supply curtailments, causing a persistent backwardation that is not healthy. Gasoline seasonality will soon be peaking over the next few weeks. "Buy Easter - Sell Memorial Day"

More sideways drifting can be expected if volatility stays subdued. Stocks look fully priced, leading to palpable investor malaise . Given tomorrow's May 1 labour holiday, maybe it's time for workers to benefit more than owners. For now, it's Labour's day.

Risk Model: 4/5 Risk On

Like a broken record, I must report that the risk model has stayed with this market for yet another week. The RSI (over-bought above 60) indicator has been stuck on a negative signal, but given the bullish sentiment, and low volatility, there has been no incentive to sell.

Copper has retreated on waning sentiment surrounding the efficacy of Chinese stimulus. I am watching the $2.75-.80 level carefully. A breach of that level would indicate structural problems with global growth are more persistent than is currently appreciated.


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