By
The
Inflation Trader
:
Everything is moving in slow motion. To some degree, this is
normal on 9/11-- when many Americans, and especially those in the
financial markets, have trouble concentrating fully. However, this
goes beyond the anniversary of the attacks. Market volumes, which I
expected to begin to pick up last week, remain anemic by any recent
standard. Volumes last Friday, on the day of the Employment report
that could well be the deciding factor in provoking QE (although I
was
already on record
before
the data as saying
I thought the Fed would ease in September), were actually lighter
than on Thursday. Only 641mm shares changed hands on the NYSE.
That was similar to the volumes on the two previous Employment
Fridays: in July 561mm shares traded at the end of July 4th week,
and August 3rd's 712mm shares was the second-lowest total that
week. But I thought those were summer numbers - it is beginning to
appear I was wrong.
The decline in volumes is either bad news or worse news,
depending on the cause. If the cause is that market-makers and
high-frequency traders have pulled back from trading, then it is
bad news because that implies less liquidity. Of course, one can
argue that having slightly wider and slightly less-deep markets is
a reasonable price to pay for having markets that don't advantage
fast-twitch trading over longer-term investing; I don't agree with
that point, but it's a normative assessment and I won't quibble
with it. If that's the only reason volumes have declined, then it's
bad news for investors (and especially large investors), but a
solvable problem.
What concerns me is that if
that
is the issue, we still should be seeing volumes rise now as there
is more news to trade - Employment, the Fed, ECB, the German high
court, and so on.
I pointed out in early August
that when markets are less-liquid, as they often are in August, it
can lead to lower volumes because the larger cost of initiating any
move implies that it takes more certainty of the result before it
makes sense to re-allocate any meaningful amount of a portfolio.
True enough, but surely the Employment report, which caused a
number of economists to change their call from "QE possible but not
likely" to "QE is virtually guaranteed", is important enough to
cause some re-allocation of portfolios?
Well, perhaps not. If there is other uncertainty, beyond just
the liquidity itself, then the hurdle for re-allocation (and thus,
more volumes) goes still higher. We have all had moments like that,
when the stock we want to sell has an earnings report out tomorrow,
and even though we want to add or subtract from our position we
often will choose to wait until that information is released - even
if the expectation for the information itself ought to already be
impounded in the price.
The uncertainty I worry about is the continued political
uncertainty. I don't just mean at the levels of the Presidency,
although Obama in his convention acceptance speech mentioned FDR
and applauded "the kind of bold, persistent experimentation that
[he] pursued during the only crisis worse than this one." Many
people (myself included) now believe that it was the
experimentation that helped extend the Depression by many years.
For an excellent exposition of this argument, see
The Forgotten Man: A New History of the Great
Depression
, by Amity Shlaes. But while the President is clearly the
experimenter-in-chief, the dramatically (and frequently) changing
landscape for financial services firms is causing a tremendous
amount of certainty among market-makers of all kinds.
If investors get the feeling of "why bother? The market is
completely manipulated/screwed up anyway," then we're probably
pretty close to the next bear market, with the good news being that
it could be the one that truly wipes out the 'cult of equity' and
allows the basing of a real bull market thereafter. I'm not about
to try to call the timing of the next downswing of magnitude. I've
been somewhat more (tactically) positive recently, although stocks
remain overvalued and analysts optimistic that the extremely wide
current margins can be maintained. But for a bull market, you need
people to buy
because they think businesses have great prospects
, not because stocks don't look too bad if your alternative is
nominal bonds. While certain businesses have good prospects (that's
always true), business as a whole doesn't feel very good or look
very good. Whatever the timing, I still think that valuations will
have to retreat a fair amount before we can have a strong upswing
again.
There are other unsettling signs, involving inflation. The
teacher strike in Chicago; the NFL referee strike: unemployment is
at 8.1% (and practically speaking, the reality is worse than that),
and yet unions are striking. This is why the data tends to show
that wages
follow
inflation, and it's also why I'm skeptical that the current high
margins for businesses are sustainable. Now, teachers and referees
don't exactly work in free markets, but it's still strange to see
in this kind of environment. Or is it? The chart below shows the
percentage of all employees under collective bargaining agreements
covered (in the CBA) by a cost of living adjustment.
(click to enlarge)
(Source: BLS, and Devine, Janice M., "Cost-of-living Clauses:
Trends and Current Characteristics", Compensation and Working
Conditions, December 1996.)
Incidentally, I should give a hat-tip to ING Capital Markets; I
originally developed that chart for a presentation I was giving on
their behalf.
The chart shows that in the weak, inflationary economic
environment that prevailed in the 1970s, one of the things that
happened is that even while the overall proportion of unionized
workers was declining (as it has done more or less consistently
since 1954), the unions were gaining strength relative to
management and able to force into CBAs clauses that tended to
institutionalize inflation. The key point here being that this
happened
even while the economy was in a growth malaise
. When the economy is weak, the protections offered by unions seem
more attractive, and businesses are less able to resist union
pressures.
Surprise! A weak economy is actually bad for business, as well
as employees. What is perhaps surprising to some is that workers
don't simply sit around and take what businesses dole out to them
because they 're afraid of losing their jobs - they do, in fact,
fight back. This is contrary to conventional wisdom, which
occasionally defends the association of slow growth with
disinflation by pointing to the fact that slack in the labor market
implies workers cannot press for higher wages. As I've pointed out
before, it is true that
real
wages can be slack when unemployment is high, but that is not the
same as
nominal
wages being slack. This illustrates one mechanism by which
employees can keep up, somewhat, in nominal terms when prices rise
even if they lose on real wage growth.
See also
Fast-Growing Synergy Resources Is Too Cheap At
Under $4 A Share
on seekingalpha.com