The year is coming to a close. The good news is that this will have been the most productive year for the economy and the market since 2007. It has been a long three years. Next year holds the promise of being even better, but we will see. Headwinds are blowing, and I have suggested non-core inflation is one headwind to watch for, but I am less concerned about it today than I was last week. Simply, I have pondered the potential and even though inflation is likely to arrive, I am now thinking it further out than 6-9 months. Interestingly, the reason I now see inflation arriving later rather than sooner is simple math.
At the end of last week, I was having lunch with the man who brought me into this world. No, not a baby doctor, my market mentor, the man who introduced me to the world of trading and investing. Over the years, we have come intellectually closer about the ins and outs of this world, and our discussions most always end on common ground, yet sometimes our perspectives on the same facts are different. Since we have mutual respect for one another, this difference is stimulating, enough so that, often, when we see the world differently and we discuss that difference, one of us will call the other a day or so later and say something like, “Ya know, I’ve been thinking about what you said and …”
Well, this is the case regarding our discussion about inflation last week. We agreed on everything but one thing – the timing. We agreed that the potential is out there, and we agreed that it would take a rapid acceleration in the economy to ignite that inflation, at least in the worldview of Ben Bernanke, which is the real issue here, and we agreed that my current approach to the market would have to change, when it does come. As, I said, our point of departure went to the word, “when,” and that understanding came down to some simple math,
Common economic understanding suggests that it will take the creation of 1.5 million jobs to lower the unemployment rate one percent. My friend thinks the Fed will not make any move to raise interest rates until the unemployment rate is below 8%, if not lower, and I agree. This means the economy will have to generate some 3.75 million jobs before hitting that mark, which is an average of 360,000 jobs (give or take) produced per month over the next year to reach the 8% unemployment rate. Is this possible? Sure, it is. Is it likely? Given the unemployment rate actually went up last month, it seems unlikely we will get to the 8% number in a year or even longer.
In all my analysis, I missed this simple yet profound calculation, as my whole perspective on the coming year is now different. The point all of us should take away from my experience is that the pursuit of market (economic) understanding never ends. If we want to succeed in this world, we must be smart and quick on the draw. One way to become smarter is to present your thinking to someone who is smart and challenge that person to find a hole. It works. My hand is still on my gun, but my grip is not nearly as tight.
Trade in the day; invest in your life
