The Inflation Recognition Moment

Before I dive into the topic of the day, I’d like to briefly discuss my recent spite trade (Growth, Value, and Spite). Specifically, I closed out my Russell 2000 put position last week after making enough to pay the electric bill 🙂 . It’s another example of why I’m not a successful short seller or put option speculator. Even when I get lucky on the timing, I tend to close the position too early, making it difficult to achieve an adequate return relative to risk assumed.

Instead of short selling and timing when stocks will fall, I prefer patience and investing after prices decline and opportunities reappear. This is not meant to disparage the art of short selling. It simply means as an investor, and over many years, I’ve gotten to know my strengths and weaknesses well. Historically I’ve achieved my absolute return goals by owning attractively priced small cap stocks and holding them until my calculated valuations are reached. It’s not as exciting as short selling, but it’s a process I’m confident and comfortable implementing — it’s what has worked for me.

With my put option speculation behind me, I’d like to focus on the labor market and tomorrow’s jobs report. I’m going to take an unusual position on this all-important economic data point by stating I believe the report is irrelevant. In my opinion, the bottom-up evidence is convincing – the labor market is very tight and wages are increasing. In fact, I feel the bottom-up evidence has become so convincing, I do not foresee anything from tomorrow’s report that will alter my views. And similar to the last time I remember labor being this tight (1999), I’m not expecting a meaningful change until asset prices decline and we enter a recession. In effect, I believe we’ve reached full employment this cycle and will remain here until the next cycle begins.

As we proceed through this cycle’s phase of full employment, I plan to continue to monitor the labor market through my bottom-up lens, with particular interest on wage gains and labor availability. In addition to monitoring the labor market through the analysis of my opportunity set, I’ll continue to accumulate anecdotal evidence and other real world examples. Some of my favorite labor market examples and updates come from reader emails.

Below is an email from an experienced investor who understands the economy and financial markets well. His recent experience while staying at a hotel emphasizes a topic that is becoming increasingly important for many businesses (especially for those attempting to grow) – labor availability.

He writes, “There were two stories that I felt I had to share. First involves our hotel. Despite having made reservations 6 months in advance, none of our rooms were ready upon arrival. We waited into the night when some families just offered to take their rooms as is so they could get some rest. The poor staff was nice enough about it but they simply didn’t have the bodies to clean rooms. Some creative manager had a brilliant idea at checkout though. They offered rewards points to guests who would clean their own rooms upon leaving!”

If reward points in exchange for customers cleaning their hotel rooms isn’t a sign of a tight labor market, I’m not sure what is! His other encounter with insufficient labor came while visiting a local pizza shop. Again, it’s not just about wages, it’s about labor availability.

“On that same trip, we went to a local pizza place for dinner one night. One of the parents was talking about how his folks had owned a pizza place when he was a kid. One of the servers overheard the conversation and offered us all the beer we could drink if this guy would jump over the counter and help make pizzas. After the rest of the place had cleared out the server/manager explained that she was on the verge of losing all of her employees as everyone was massively over-worked and they simply couldn’t find help.”

Another reader sent an article about a convenience store chain in Texas called Buc-ee’s. The company hangs a board advertising its positions and wages in its stores (see picture in article: link). It’s a good article illustrating how companies are aggressively competing for labor and being forced to pay wages well above state minimums. For example, the minimum wage at Buc-ee’s starts at $14 an hour versus Texas’s minimum wage of $7.25 an hour.

As Q2 earnings season approaches, I will be monitoring business labor and wage trends closely. Based on Q1 operating results and earnings reports released in June, I believe the labor market remains tight. While tomorrow’s jobs report will not alter my views, I’m well aware many investors will be paying very close attention. And I suppose even I’ll tune in to learn if tomorrow’s report will be the catalyst that causes investors to finally acknowledge wages and inflationary pressures are rising. I call it the inflation recognition moment. What exactly causes it remains a mystery, but barring a sharp decline in asset prices, I’m expecting and prepared for its arrival.