Random Musings on Markets, Part Deux

Happy Friday! While many folks see the summer as the “doldrums”—an idle period featuring beaches, umbrella drinks and air conditioning—this summer is off to quite a newsy start. This week was no exception. Here is our attempt to round up some biggies—US inflation data, the Supreme Court nominee, UK political hijinks and more tariff talk.

‘Flation!

US CPI inflation hit 2.9% y/y in June, notching another six-year high and creating a bit of fear because June’s wage growth didn’t keep up. Keeping with the human tendency to extrapolate all recent moves forward, media coverage warned more price rises could be in store, bringing consumers great pain.

We see a couple things wrong with this. For one, a lot of the increase stemmed from gas prices’ recent rise. While year-over-year inflation rates may stay elevated in the coming months if gas prices don’t back off, that doesn’t mean prices are continually rising—they could stay at the same level but still “rise” on a year-over-year basis due to math (steady numerator divided by lower denominator). Two, inflation and wage figures are broad averages. CPI doesn’t reflect the actual cost of living for most folks, and the wage growth figure doesn’t track what actual people are making—it tallies the growth in the broad total pay. Measures that track actual earners, such as the Atlanta Fed’s Wage Growth Tracker, typically show faster growth (3.2% y/y in June, as it happens).

As for the broader economic or market impact, we don’t think “negative real wage growth,” which is jargon for “wages that don’t keep up with measured inflation,” should do much harm. Follow this link and you’ll see a chart we made at the St. Louis Fed, which shows wage growth has trailed inflation numerous times during this and prior economic expansions without causing things to turn south. Examples include most of 2012, 2005, the early-to-mid 1990s and most of the 1980s bull market. Across the pond, UK inflation has outstripped wage growth for most of the current expansion and bull market. In our view, this simply isn’t a predictive statistic.

We Have a Nominee

Monday, President Trump nominated Brett Kavanaugh to replace retiring Supreme Court Justice Anthony Kennedy. And so began a media firestorm, in which folks dove deep into his history to try to divine how he will act if nominated. We guess that is natural. The Supreme Court does rule on some consequential matters and is widely watched by the public. With that said, few of these rulings impact markets. So, love or hate this appointment, it doesn’t seem likely to be a big factor in this bull market. Further, the Supreme Court—being a panel of nine people—isn't a gameable market function. Even if the court did take a market-related case, forecasting the outcome would be exceedingly difficult, if not impossible. It is a little like trying to forecast the Fed, only with more legalese and less fedspeak.^[i]

Rule changes in 2013 and 2017 mean only a simple Senate majority is needed to confirm judges, including Supreme Court justices. So, given Republicans’ current 51 – 49 edge, Kavanaugh’s confirmation seems likely. While it is possible this shifts the court’s ideological balance, it is worth noting most cases aren’t decided by 5 – 4, “party line” votes. In this court term (which ends September 30) through June 29, only 19 of 71 decisions were 5 – 4.^[ii] 14 of those were “party line.” Most often, decisions are on legal technicalities and feature more uniformity. In this term to date, there were 28 unanimous rulings.

Checking in on Chequers

After last Friday’s all-hands cabinet meeting at UK Prime Minister Theresa May’s country getaway yielded an agreement on an alleged “soft Brexit,” this week brought lots more political news. Foreign Minister Boris Johnson and Brexit Minister David Davis (along with a handful of junior ministers) can now add the word “former” to their titles, as both resigned in protest. The now-former ministers favored a sharper break with the EU, with Johnson colorfully calling the plan, “a polished turd.” This highlights the persistent divide among May’s Conservative Party on the issue, which adds to Britain’s extremely gridlocked government.

It also leads many to speculate a leadership challenge is in store for May. It would take only 48 of the Conservative’s 317 members of parliament to call a confidence vote—a total hard-Brexit Tories likely could achieve. Many think Johnson has ambitions to take May’s place. While that is certainly possible, there are reasons to be skeptical. Consider: May’s minority government is in power only because of an agreement with Northern Ireland’s Democratic Unionist Party (DUP). They favor May’s plan, given they share a land border with EU-member Ireland. A harder Brexit could mean a physical border, putting the Good Friday Agreement that brought peace to Northern Ireland at risk. The likelihood they support a Conservative government targeting a hard Brexit is low. So ironically, her party’s poor showing in the snap election May called in 2017 could actually preserve her government.

More US Tariffs on China

Midweek, tariffs on China took center stage again, as the Trump administration unveiled a comprehensive list of many products it would target in another round of tariffs. This time, the list targets $200 billion in goods imports. There is a two-month window for companies to comment, Trump to reconsider or US/China negotiations to forestall them. But in our view, even if Trump does enact this round, this likely doesn’t change the scenario much for stocks. As we have written, bilateral tariffs are too easy to dodge—either by shipping goods through third parties, substitution or companies’ changing where they produce exports from. (Call it the Hog model.) This mitigates the impact. 

Even if they don’t dodge these new tariffs, the impact is likely still too small to materially ding stocks. Recently enacted plus all threatened US tariffs—including what seem to be mere passing references to taxing global auto imports—and currently enacted retaliation from our trade partners brings the total to about $642 billion in goods that would be taxed. Applying the rates discussed means the maximum tariff impact is roughly $106.5 billion dollars.^[iii] That isn’t chump change to us, but global GDP is about $87.5 trillion according to the IMF’s latest World Economic Outlook.^[iv] That means these tariffs are about 0.12% of global GDP.   

This doesn’t mean tariffs are good. We don’t think any tariff is. But, in our view, those discussed lately still don’t seem to have the size or surprise necessary to end the bull market.

Enjoy your weekend!