With all of this talk about the economy improving and potential for rates moving higher, it got me thinking. What if we finally see higher inflation this year?
In order for this to happen, we would need to see economic activity pick up enough to require more hiring by companies. As competition in the labor market would theoretically heat up, wages would likely begin to rise, and this would create the kind of inflation we are looking for to really get our economy going.
Don’t look now, but it appears these two “needs” for inflation may be coming to fruition:
- Small Business Survey Upbeat (Dr. Ed)
- “…the percent of firms expecting to increase employment rose to 6.3% in December. That may not seem like much, but it is the highest reading since October 2008. “
- Empire State Manufacturing Activity indicates faster expansion (Calculated Risk)
- “The general business conditions index rose ten points to 12.5, its highest level in more than a year. The new orders index climbed thirteen points to 11.0, a two-year high.”
Both of these signs bode well for the economy, but what about the market? If hiring and wages were both to pick-up, we would almost surely witness a compression of profit margins in the short term. Factor in tapering by the FED, higher yields which would be very attractive if the market loses momentum, and the ominous “warnings” throughout the market, could we actually be on the verge short-term pause or pullback in the market? How will investors respond to this new environment? Would they blindly sell on falling margins or instead turn their eyes to newly revived revenue growth from stronger consumer spending?
Long-term, I think this is a great problem to have. However, there are a lot of “what-ifs” in the air at the moment in regards to the US equity market. Will we have a “regular” year which is up but witnesses a return of volatility and one or more 10%+ drops, or will we see a flat to down year as investors cope with compressed margins yet strengthening economic fundamentals? I remain very bullish over the long-term as we all should be, but I am becoming more cautiously bullish by the day in regards to the next 6-12 months.