Friday's news — that nonfarm payrolls increased by 57,000 jobs (when they were expected to fall by 25,000), and that the unemployment rate held steady at 6.1% — is just a down payment. Why is job growth inevitable? Corporate profits are surging — and that, sooner or later, leads to jobs. It has to happen: Companies are going to want to reinvest those profits to make more profits. It takes people to do that.
You don't know about the earnings recovery? Well, wake up! If you exclude the tech sector, trailing 12-month earnings for the S&P 500 are now at an all-time high. Earnings in the tech sector, while off the highs of several years ago, are up 33% in less than a year — and forecasted earnings for tech are being revised upward now at an annualized rate of 65%. No one seems to want to admit it, but this economy is catching fire, and jobs can't be too far from showing a real turnaround.
The other reason why bonds are at risk is the specter of inflation. Right now the market is so focused on the opposite of inflation — deflation — that when inflation breaks out, it will come as a very ugly surprise. And as every investor knows, when inflation expectations rise, bonds get crushed.
The signs of incipient inflation are actually quite evident, if you're only willing to look at them honestly. Gold — the most sensitive inflation indicator of all — has been trading with extreme volatility, flirting with decade-long highs. Oil and other commodities have been moving up, too. Even the traditional measures of inflation like the producer price index and the personal consumption expenditure deflator are starting to show alarming growth.
The first source of inflation is the Fed's obsession with jobs. As the economy recovers, the Fed needs to raise interest rates to track the improving growth rate of the economy — jobs or no jobs. If they don't, the result will be inflation. So while job growth is inevitable at this point no matter what the Fed does, if it takes too long to materialize we'll have inflation, too.
And the recent decline of the dollar is playing into inflation risks, too. I complained last week that the Bush administration is risking global economic growth by bullying trading partners like China and Japan into revaluing their currencies — which has the effect of devaluing the dollar. But it's more than just a matter of growth. When investors get the idea that the U.S. wants a weaker dollar, they're going to not want to hold dollars — and the world-wide demand for dollars will fall. If the Fed doesn't reduce the supply of dollars commensurate with the lower demand for dollars, inflation will result as surely as night follows day. Obsessed with job growth, it seems pretty likely that the Fed will make that mistake.
Put it all together, and it's heads-you-lose and tails-you-lose for bonds. If we get job growth right away, the Fed will raise rates right away — bonds lose. If we don't get job growth right away, we'll get inflation — bonds lose.
Are you beginning to see a pattern here? Bonds lose.
Donald Luskin in www.smartmoney.com.... |
