Whatever might be the short-term follow-up (or -down) on Friday’s and Monday’s drop, I remain bullish because the outlook for earnings remains very upbeat. Industry analysts have raised their consensus S&P 500 earnings estimate for 2018 by $9.00 per share over the past seven weeks to $155.26 during the week of February 2. That’s mostly on guidance provided by managements during January’s Q4-2017 earnings season about the very positive impact of the corporate tax cut enacted late last year. The actual Q1 earnings season is still ahead, starting in April. By then, corporations are likely also to report that the weak dollar (down 7.7% y/y) has boosted their earnings.
Nevertheless, the latest panic attack isn’t about corporate earnings. Rather, the fear is that wage inflation is making a comeback and that the Fed will respond with more aggressive monetary tightening. Initially, higher inflation and interest rates could depress valuation multiples, as happened on Friday and Monday. Eventually, tighter monetary policy could cause a recession directly by tightening credit conditions or indirectly by triggering a financial crisis.
Wage inflation may finally be picking up, but not by much. Shortly after she was appointed Fed chair four years ago, Janet Yellen said she expected that the Fed’s easy monetary policies would boost wage inflation from around 2.5% to 3.0%-4.0%. It just may reach that zone now that she has left the Fed. However, the markets may have overreacted to data on wages released Friday morning in the Employment Report.
Average hourly earnings (AHE) for all workers rose 2.9% y/y through January, the highest since June 2009. However, the AHE for production and non-supervisory (P&NS) workers rose by 2.4%, which is roughly where it has been for the past few years. P&NS workers account for 82% of all private-sector payroll employment.
