Is Economics 101 Wrong?

By: Kent Engelke | Capitol Securities

Economics 101 dictates low employment causes higher wages. Conversely, high unemployment dictates lower wages. Perhaps Economics 101 is wrong and today is the other bookend that commenced in the late 1970s.

To remind all, wages were surging in the late 1970s as cost of living adjustments (COLAs) became embedded in wages because of higher inflation. Most economists were stymied by rising wages as unemployment was close to double digits. Treasury yields were also close to double digits and real or inflation adjusted yields were around record levels.

Fast forward to today. The unemployment rate is at 3.9% and at the lowest level since 2000. Wage inflation is benign. Similar to the above, this is inverse of what most expect. Treasury yields are nominally higher than their historical lows and real yields are around record lows.

What gives? Yes, there are signs of wage pressures in the more inclusive employment cost index that is released on a quarterly basis, but most focus on the BLS monthly print. Perhaps it is the result of a labor participation rate (LPR) that is still hovering near historical lows. Yes, job creation remains well ahead of the natural growth rate of the labor force, but the pool of available workers, workers that are not included in the data are gargantuan, the result of government policies.

As this pool shrinks, I believe wages would then begin to rise.

The volatility at the end of last week was incredible. At one time Thursday, the Dow was down almost 400 points declining to its 200 day moving average only to rebound sharply by the close to end essentially unchanged. Friday, the Dow was off over 130 points, reversed and advanced over 400 points, to end higher by 325 points.

Wow! SkyNet is in control.

Commenting about oil, WTI closed Friday around $69.75/barrel, up almost 2%, the highest level since November 2014. Crude is now up about 50% in a year and 170% since its early February 2016 lows. For the first time in many years, a nominal geopolitical premium is now becoming embedded in prices.

The estimates vary greatly as to the impact to supplies if Iranian sanctions are again levied. Some are projecting a 2 million barrel decline, while others predict 500,000 barrels. Regardless, if sanctions are reinstated, oil supplies will further tighten.

Moreover, the vast majority of non-state and state oil producing firms are commenting about the possibility of a supply shortage given the lack of infrastructure spending in large upstream facilities.

Is the oil market about to face a perfect storm, a storm that is reminiscent of the one ten and twenty years ago? I place the odds at 75%. A major difference between today and yesterday are valuations. According to Goldman Sachs, oil equity is priced at the sharpest discount to crude in history and the lowest valuation in over 50 years in both a comparative and absolute manner.

What will happen this week?

This week the economic calendar is comprised of several inflation indices, sentiment indicators and inventory data. How will the data be interpreted?

Last night the foreign markets were up. London was closed over a holiday, Paris was up 0.07% and Frankfurt was up 0.46%. China was up 1.48%, Japan was down 0.03% and Hang Sang was up 0.23%.

The Dow should open nominally higher. West Texas crude is above $70 for the first time since November 2014, as possible re-imposition of some US sanctions on Iran are now imminent. The 10-year is off 2/32 to yield 2.97%.

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