Wednesday, May 17, 2006

What's on the Horizon

I was planning on writing about todays DOW/ equity market sell off. As you all probably know, the DOW got beat pretty hard today to a tune of 214 points, or about a 1.88% hit. The catalyst was the core CPI report that was higher than expected causing heartburn to the equity markets. Surprisingly, the bond market had a relatively tepid response. Not surprisingly, the market appears to be realizing the future is a little hazy. Afterall, a lack of certainty causes fear, and fear will drive the market southwards.

Billmon agains explains it better than I could.

If wage gains are already slowing, or at best just noodling along at a meager 2.5% rate (about half the headline inflation rate) what will they do if the economy does downshift to what the Fed considers a more "sustainable" (i.e. noninflationary) pace? Ouch. But if economic growth doesn't slow, or doesn't slow enough, will oil and other commodity prices keep rising -- pushing up headline inflation and making those 2.5% wage gains seem even more inadequate? Double ouch.

Theoretically, as well as ideologically, the stock market doesn't give a flying fuck about the plight of the worker -- as long as the sales growth needed to keep earnings growth perking along comes from somewhere. Shitty wage growth is good news. It boosts profit margins, and only dumb old Keynesians worry about how those underpaid workers are going to buy all that stuff they've been making (not to mention all the stuff being shipped in from China.)

But I think it's finally dawning on the equity cowboys (as it usually does after the Fed has been bumping rates up for a while) that the end result of a tightening cycle isn't likely to be positive for earnings, even if it doesn't lead to a full-fledged recession. What's different this time, I suspect, is that the market is beginning to realize this may be more true, not less, because the enemy is cost-push inflation instead of the old wage-pull variety.

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