Eric Green at TD Securities outlines some reasons to be wary of US equity prices
- Says the relative value in equities has been high given low yielding alternatives elsewhere
- And ... at face value the strong jobs and tepid earnings growth today should be good for equities
But ... "some nasty underlying dynamics":
- The strong USD and higher policy rates on the way
- And... "something more fundamental is taking shape and the report today suggests we are headed for another weak quarter for productivity growth. That has nasty implications for equities that together with higher policy rates will narrow the wedge between equity earnings yield and the 10year treasury yield"
- Output in Q1 is looking to be weaker than expected as GDP is shaping up around 2.0%
- With output on the low side the strong job growth and hours worked point to weak productivity growth
- With another decent quarterly gain in earnings (recall January was up 0.5%) it points to another strong gain in unit labor costs (... surged 4.1% in the last quarter). The Fed regards this as a good development, one that will eventually support higher underlying inflation.
- For stocks it means margins have peaked and are set to compress at a time when valuations are very high, the USD is firming, and the Fed is coming into play
- profits as a share of GDP will continue to diminish while labor costs rise and margins get squeezed
- The Fed is moving away from the old paradigm in which a support to wealth creation plugged the hole in aggregate demand. The Fed is moving toward a paradigm in which a recovery is supported by stronger income, not wealth. Odds are good that transition is taking shape. It is one the Fed will embrace, not shy away from.
