Trust Me, Inflation And Higher Interest Rates Are Good For Stocks...

Unless we are headed into a hyper-inflationary period such as that we saw in the mid-1970s and early 1980s.

Inflation and Interest Rates

This is a nuanced situation. Most people writing about inflation and rates or programming computers that implement trading programs to react to news that might change their trajectory do not get the complexity of what they are writing about. They operate with the simple proposition that both are bad. Most have not studied the issues facing the market 40 years ago. Many were not even alive. A moderate increase in rates and inflation (not runaway) would be very beneficial. If you, in your heart-of-hearts, believe that type of severe environment is on our doorstep, and if you are really good at market-timing, be my guest … Sell! If the moon, the sun and the stars align you will save yourself a lot of pain. If, on the other hand, inflation and rates move up at a gradual pace over the next few years you could be missing out on another wonderful leg up in the current bull market.

I'm in the moderate pace camp

Why? Because I believe we are in the beginning stage of coming out of a two-decade period of severe deflationary pressures caused by the advent of world-wide competitive labor and capital markets… in a word, globalization. Globalization has kept wage growth in check in the developed world and it has kept pressure on manufacturers to keep prices low to compete with foreign made goods. In the case of US corporations, global competitive pressures have removed an important tool from their growth tool box… pricing. For most of the past 20 years, corporations have had to rely on unit growth and financial engineering (mergers and acquisition and stock repurchases) to move the profit ball ahead. There has been no pricing. Globalization continues to be a drag on inflation and will probably continue to be so moving forward. This would bolster the case for a measured pace on the inflation front and, as the price of money in part depends on inflation, it would seem to augur well for moderately rising rates. My sense is, based on every Fed pronouncement I've heard, this is where the Fed's collective judgement is today.

In the meantime, most central banks, including the Fed, have been on a mission to re-stimulate some inflation. Remember, this is a good thing if it gives corporations some pricing power. Since the United States entered the re-inflation game much earlier than most world economies, we may begin to see the benefits earlier than most. Take this headline from Monday, April 30, as an example: "McDonald's shares soar as menu price increase feeds earnings beat." McDonald's (NYSE:MCD) stock rose almost 10 points (6.3%) on that news, closing up 4.2% on the week. And it was not just the US that made '"Mickey D's" numbers. The strength was global. Although McDonald's leads with its cheap-eats menu, it seems consumers are stepping up and paying higher prices for their premium offerings. The money printing may finally be working.

The important point here, as it pertains to future earnings for many companies, is that pricing has been a missing ingredient in the profit equation. It may be on its way back and may provide significant future earnings upside surprises.

Media Schizophrenia

According to Psychology Today:

Schizophrenia is a disabling, chronic, and severe mental illness that affects more than 21 million people around the world. Symptoms include hearing internal voices, having false beliefs, disorganized thoughts and behavior, being emotionally flat, and having hallucinations. These symptoms may leave a person feeling fearful and withdrawn. Their disorganized behavior can be perceived as incomprehensible or frightening to others.

People with schizophrenia may not make sense when they talk. They may sit for hours without moving or talking, or may seem like they are talking to themselves."

Schizophrenia is obviously nothing to joke about. It is a serious mental disorder. However, there are certain symptomatic traits that the schizophrenic personality may have in common with the financial media. They are highlighted above and exemplified below.

Here are 2 headlines from the CNBC website pre-market Friday, May 5. Both reflecting a reaction to the April Jobs Report… First the headline numbers from the Wall Street Journal.

"The U.S. added 164,000 new jobs in April, missing economist expectations of 195,000. But the unemployment rate fell to 3.9%, the lowest since 2000. Wage growth remained sluggish. Join us as we dig through the numbers." (WSJ.com)

(Last Updated May 4, 2018, at 10:00 am ET)

This prompted a negative CNBC post on the market because the numbers missed consensus by a wide margin:

"US stocks set for negative open after jobs report misses expectations"

In fact, if you had been soaking up all the sage commentary from CNBC and its minions for the past week, this should have been greeted as positive as it indicated the economy was not running as hot as some who fear inflation might have thought and this might also indicate the Fed could go easier on its path to higher rates.

Instead, they jumped to a negative, incorrect conclusion (the economy is weakening) versus their previous commentary.

Here is a link to the post from Friday morning. You may notice their message and headline changed significantly by the close.

They mention the jobs report, but not in a negative way, and plow on through to explanations of why the market ended up

more than 300 points… Amazing!

At the same time, the above negative post hit…

CNBC on the bond side posted this:

"US 10-year Treasury yield hits two-week low after jobs report"

The bond guys took the report in a similar vein as evidence of a potential slow-down in the economy, a flight to safety, a rush to buy bonds… prices up and yields down.

Similarly, the link attached to this post in the morning led me to this article at the market's close - "Treasury yields mostly higher after jobs report." They were selling bond. It was safe to go back in the market.

Sounds Schizophrenic to me (false beliefs, disorganized thoughts and behavior … may not make sense when they talk). More importantly it sounds totally stupid.

Finally, trust me on this - despite the constant noise from the media, inflation in moderation is a good thing for earnings and moderately rising interest rates (coming off a crisis, low base) will not kill the economy or this bull market.

What is your take?