Having identified virtually every single asset bubble of the current cycle (as well as a few extra), SocGen’s cranky strategist Albert Edwards has found yet another place where there is irrational exuberance: vacations, and ever the optimist, Edwards has a message for Americans: enjoy it while you can, because it won’t last. In a note titled “Who needs wage inflation when even vacations have become a bubble” , the SocGen strategist observes that “more Americans plan to take a holiday in the next six months than ever before (see chart below)” and complains that there is “no wonder it was so difficult to book hotels in Yosemite National Park and Lake Tahoe next May!”
The problem with this latest bubble is that while a record number of Americans are taking vacations, far fewer can actually afford it when one strips away the fleeting asset bubbles created by central banks. As a result, record vacations have become only the latest indicator of consumers’ confidence in rising wage growth, which however has yet to materialize. “I know US consumer confidence has been booming on the back of a surging equity market, but cheap money has also prompted the consumer to book holidays galore.”
Which means that once the punch bowl is taken away, so will the downtime: “When the bubble bursts, households will be mighty pissed that it?s not just their wealth that evaporates in front of their eyes but their ability to vacation like never before.”
There is a paradoxical flipside: if indeed consumer confidence in rising wages is warranted, explaining the record vacation plans, this could be the worst possible news for the Fed. As BofA’s Barnaby Martin warned earlier today when looking at the credit bubble, should higher-than-expected inflation emerge, “this would be the big negative for credit markets down the line.” It would also be negative for all other risk assets, as the Fed is forced to accelerate its tightening cycle, in the process bursting all asset bubbles that record low rates have blown over the past decade.
Is there reason to assume that wage inflation is – finally – just around the corner? Not if only looks at the unemployment rate (and its first derivative, the Phillips curve), which is only low because a record number of Americans are now outside the labor force. As Edwards writes, “there are many persuasive explanations for why wage inflation is failing to accelerate that do not hinge on the diminution of union power. In the US for example you would undoubtedly have seen charts such as the one below. It shows that although the unemployment rate is very low (shown here as a high employment rate), the sharp fall in the participation ratio means that employment as a share of the working age population has not risen anywhere near the previous cyclical peaks that might induce accelerating wage inflation”
Which brings us to the Phillips curve and even the Fed’s own admission that it may no longer be meaningful. But what if it is? Here Edwards plays the Devil’s advocate and writes that “The supposed flattening of the Phillips Curve (which effectively means that low rates of unemployment result in more moderate wage inflation) is probably the most important economic event boosting asset prices at the moment, because it is prompting a much more relaxed pace of central bank interest rate increases than would usually be the case.”
After citing several goalseeked examples why the Phillips Curve may, in fact be alive and well – thereby validating the “vacation” argument – Edwards touches on a very important point, namely that “what really matters to policy makers as a driver for underlying price inflation is not so much wage inflation as unit labour cost inflation. That is because rapid wage inflation may exert no cost push inflationary pressure on output prices if output per worker (productivity) is rising even faster.“
And while few would be so bold to suggest that US labor productivity is strong, Edwards notes that “this year has seen a transformation in US labour cost pressure as a combination of benign conventional measures of wage inflation and a moderate, but long-awaited, rise in productivity growth has crushed unit labour cost growth below zero. At a time when we are all scratching our heads as to why core CPI inflation has declined so sharply, this may offer a convincing explanation (see chart below). Labour costs comprise the bulk of corporate costs and so the recent decline in unit labour costs has allowed CPI inflationary pressure to abate.”
This leads to another favorable outcome, as pertains to corporate profits which may not be due for a drop any time soon if Edwards is correct:
the corporate profit margin squeeze seems to have subsided, as unit labour cost inflation has dived well below corporate output prices (see chart below). Traditionally we have viewed declining profits and profit margins as a good leading indicator of recession, and so on this data that imminent threat has certainly receded (that is me being relatively upbeat!).
And while all of the above may be good news for Main Street, it is hardly what Wall Street, or the Fed, want to hear: after all, rising wages has been the only “missing link” to accelerate a broader inflationary spike; the kind of spike that could unleash what Edwards just last month dubbed the “Nightmare Scenario.” Here is Edwards on the one catalyst that could unleash another “Black Monday” market crash:
The nightmare scenario for equities would be if US wage inflation flickers back to life and investors not only decide that they are too far behind the Fed dots, but they also decide that the Fed itself is behind the tightening curve. In that scenario yields would jump sharply higher across the curve, but especially at the short end and the dollar would soar.
So which is it: are Americans correct about their chances of a raise, or is the “vacation bubble” simply a function of record stock market complacency? Having predicted earlier in the year that wage inflation is imminent, only to admit he was wrong a few months later, Edwards refuses to make a firm commitment, but cites an observation made by his SocGen colleague Kit Juckes earlier in the week
“What matters from here, of course, is the outlook for inflation. Clients tell me that strategists fall into one of two camps – those who believe faster wage growth and the revival of the Phillips Curve is just around the corner, and those who have completely given up: they see no reason to look for higher inflation and they therefore have no reason to expect the range in bond yields to break. The ranks of the latter camp have grown dangerously large and this is now the consensus view. Maybe that’s why the dollar is making such heavy weather of bouncing.”
Edwards conclusion: it’s all about the (missing) wage inflation: “Indeed throughout this cycle wage inflation has been ?the dog that failed to bark?. The risk is that the market is hugely vulnerable if it hears a distant bark, let alone feels its bite.” Of course, in a Catch 22, if the bite is indeed bad enough, and forces the Fed to hike in a rush, sending risk assets sliding, it goes without saying that the impact on vacation plans will be far more dire than if the hoped for wage growth never materializes. And while we have yet to see definitive evidence that wages are indeed growing at some torrid pace, those Americans who have yet to take advantage of the vacation bubble may want to do so sooner rather than later… just in case Edwards is right. Because while vacation plans are a record high now, they it was just under a decade ago when they hit all time lows, roughly when the S&P was trading just around 666.