I am going to take a well-deserved hiatus but I wanted to list some “quick hitters” on the issues facing the markets in the coming weeks. The Yellen testimony has been digested and regurgitated (ad nauseam) and the bottom line is Chairwoman Yellen is singing from the same hymnal as her predecessor. The stock market investors/traders are comfortable with a known known and as readers of NOTES are well aware markets appreciate as much certainty as possible. BUT I WARN EQUITY BULLS WHO BLINDLY FOLLOW THE FED LIQUIDITY MODEL: Janet Yellen is a labor economist of Keynesian predilections.
Why does this matter? I am posting a beautiful Bloomberg chart going back to 1947 showing corporate profits as a percentage of GDP. Also, I show the profits/GDP chart going back to 1999. Study this chart well, for it is the basis for Keynesian efforts to raise wages. There is NO QUESTION THAT CAPITAL HAS BEEN REWARDED VERSUS LABOR FOR THE PAST 25 YEARS AS GLOBALIZATION HAS PUT TREMENDOUS PRESSURE ON WAGE RATES.
The argument becomes that in order to create more DEMAND wages have to rise. As the Bloomberg chart reveals, during the last 67 years the average rate of corporate profits as a percentage of GDP is 6.24%. The economy is now running at a rate of 9.9915%. If Yellen cares about anything outside of the JOBS SITUATION, it is the growing discrepancy in income levels. The Keynesians will make the case that higher wages will drive overall demand (I am making no judgement about this), merely raising the idea. If LABOR is to get a larger share of GDP is will come at the expense of corporate profits. Every FED chairman brings their own work and disposition to the job. At this juncture this is not a concern but it is certainly an issue for the EQUITY-CENTRIC correlation crowd.
***Note to BOE Governor Mark Carney. Yesterday the BOE governor announced that the market should forget about the “forward guidance” and in fact, “… the central bank would no longer tie its future policy decisions to any particular economic indicator.” Now that the unemployment rate has dropped faster than the Bank of England predicted, Mr. Carney wants to disavow the pledge about the 7% threshold holding any relevance to economic policy. It seems that the BOE has acknowledged that there is still plenty of spare capacity in the U.K. economy so that the central bank doesn’t have to worry about inflation. It appears that after all the discussion about QE and forward guidance central banks are back to being very concerned about Ben Bernanke’s beloved “OUTPUT GAPS.”
Mark Carney’s change in direction takes on greater importance with Stanley Fischer being the Fed Vice Chairman. (Mr. Fischer is on record being opposed to the use of “forward guidance.”) Will this lead to a schism between Yellen and her vice chairman over how to communicate with the markets and the economy. It is always positive for policymakers to “change when the facts change” but central bankers have to be careful of losing their credibility as markets respond to their financial guidance.
***I want to return to the piece I wrote on Tuesday about the ouster of Berlusconi and selection of Mario Monti. In yesterday’s Financial Times, Italian President Giorgio Napolitano wrote a lengthy letter questioning the factual basis of Mr. Friedman’s piece and soon-to-be-published book. President Napolitano cites at length his recollection of facts in regards to Berlusconi’s removal, but I advise the Italian president that a politician’s rebuttal over facts has a tendency to lead to further investigation into the facts in question and most often it is the accuser that gets substantiated. Regardless, Mr. Friedman seems to have roused a debate that Giorgio Napolitano should have let die on its own vine. Look for Mr.Berlusconi, a master spinner, to enter the fray and keep the story alive. Today,it was rumored that current Prime Minister Enrico Letta is going to resign so as not to force a new election and thus allow President Napolitano to select Matteo Renzi to form a new coalition. Pay no attention to the man behind the curtain.