Doc Holliday, Jay Powell, Donald Trump & The Piano

Author: David R. Kotok, Post Date: October 12, 2018

“Ready, Fire, Aim”?

In Understanding and Managing Public Organizations, Hal Rainey makes the point that “the intangible issues of culture, values, human relations – matters that many managers regard as fuzzy and unmanageable – can and must be skillfully managed.” The contrary approach, which is favored by many companies and government agencies, can be summarized as “ready, fire, aim.” (Understanding and Managing Public Organizations,


Market Commentary - Cumberland Advisors - Please do not shoot the pianist. He is doing his best

Rainey’s insight will prove relevant as we consider this week’s stock market carnage.

Politico offered this explanation for the carnage:

“WHY MARKETS TANKED AND WHAT’S NEXT — The real surprise is it took this long. Wall Street has been shrugging off a rising 10-year yield, fear over the trade war with China and uncertainty surrounding the midterm election for way too long. The S&P 500 did not record a single move up or down of 1 percent by the closing bell in the third quarter. That hasn’t happened since 1963, according to LPL Financial.

“That kind of calm is what’s abnormal, not the 3 percent decline in the Dow and S&P on Wednesday and the 4 percent decline in the Nasdaq. President Trump blamed the drop in part on the Fed, saying the central bank had ‘gone crazy.’ He also referred to a ‘a correction we’ve been waiting for,’ which is a much better explanation.”
(Politico, 10/11/2018, 8 AM EDT:

Now, in order to assist the fact checkers, here is the full Trump quote:

“The Fed is making a mistake. They’re so tight. I think the Fed has gone crazy. So you could say that, well, that’s a lot of safety actually, and it is a lot of safety, and it gives you a lot of margin, but I think the Fed has gone crazy.”
(Politico, 10/11/2018, 8 AM EDT:

Here’s our take.

The (in)famous Doc Holliday ( occasionally played the piano at the legendary Silver Dollar Saloon in Leadville, Colorado. When Oscar Wilde appeared at the Tabor Opera House across the street, he would cross the street to the saloon for a drink or two after his lectures. Wilde noted that there was a sign over the piano that read: “Please do not shoot the pianist. He is doing his best.” (Source: a personal visit to the legendary Silver Dollar Saloon)

The sign over the piano could apply to today’s Federal Reserve. The Fed now has over a 100-year history. It is doing the best it can. Let’s not shoot it.

At the recent NABE conference, Fed Chairman Powell said,

“This historically rare pairing of steady, low inflation and very low unemployment is testament to the fact that we remain in extraordinary times. Our ongoing policy of gradual interest rate normalization reflects our efforts to balance the inevitable risks that come with extraordinary times, so as to extend the current expansion, while maintaining maximum employment and low and stable inflation.”

He added that “The economy is seeing a “remarkably positive outlook … and a modest steepening of the Phillips curve would be unlikely to cause a significant rise in inflation or demand a disruptive policy tightening. Once again the key is anchored expectations.” He welcomed the recent rise in wages and stated, “Higher wages alone need not be inflationary.” We thank Mike Englund and his team at Action Economics ( for capturing Powell’s quote with precision.

There is a lot of Fed-related jawboning about the recent employment report. Many folks argue that it was distorted by hurricane effects, so we need another month to gain clarity. With Hurricane Michael now added to the natural disaster list, we may hear the same chorus when the October data is compiled and released.

Meanwhile, the inflation outlook is coupled with the question of whether or not wages are trending upward and accelerating. And the negative economic effects of the Trump-Navarro trade war are only beginning to show up in the data. On a positive note the new NAFTA agreement with Canada and Mexico has reduced anxiety in markets and seems to have stabilized a trending deterioration in sentiment. That improvement (the situation is now less worse than expected) may offset the impact of the US-China lack of progress. Without a directional policy change, the China-US imbroglio could prove very serious. The fears that we articulated in our Thucydides Trap pamphlet are sadly being realized. (The pamphlet is available here in PDF form: “Lessons from Thucydides,”

Of course, for the investor the issue is, what does all this mean for future Fed policy and interest rates?

The Treasury yield curve has abruptly steepened. We expected that to happen, given the one-time influence of a special tax provision that expired in mid-September. See “Why the Yield Curve Is Flat and Why It May Steepen,” And we looked to the high-grade muni curve for some guidance. See “The Tale of Two Ratios: Shorter and Longer,” The pricing of munis is set mostly by high-income American investors. The muni curve was steep and continues to be so. Treasury yields result from investments by both Americans and foreigners – a blend of influences. Thus the muni curve may be a better source of high-grade forecasting power. We think it deserves some respect.

So what about wages and inflation?

We updated our series of Beveridge curves. Nearly all of them point to a wage acceleration coming. (We will send any reader the 8-chart series if you provide us with a full snail-mail address.) That series depicts specific unemployment rates crossed with other indicators like job openings or quits. It tracks the last expansion period, the Great Recession and financial crisis, and the recovery since. When viewed together, the curves make a compelling case for an acceleration of the upward trend in wages and for rising inflation. Beveridge curves tell you Fed Chairman Jay Powell may soon see his “historically rare pairing” appear more normal.

My friend Michael Drury at McVean Trading had this comment following on his observation that “Wages have grown at a 3.2% apace over the past 11 months.” He expects 3.2% to continue and notes that “3.2% means wages are compensating workers for 2% inflation and 1.2% productivity growth.” Meanwhile, other economists argue about that productivity growth and ask, “Where’s the beef?”

My friend and fishing buddy Danny Blanchflower is a labor economist and ardent student of Keynes and Beveridge. Danny is a Dartmouth professor of economics, Bloomberg contributor, former Bank of England board member, and serious academic researcher. He and I have discussed the concept of NAIRU, the non-accelerating inflation rate of unemployment – in other words, the level of unemployment below which inflation rises. (For more on NAIRU see

NAIRU is not observable, so it has to be estimated. Danny notes that there were periods in history when the estimate for NAIRU was as low as an unemployment rate of 1 to 2%. He cites Keynes and Beveridge for that history. He also notes how central bankers routinely miss on their estimates of NAIRU. That means they are playing the saloon piano when it isn’t tuned.

Danny uses something he calls the U-7, which quite simply is the U-6 unemployment rate minus the U-5 unemployment rate. He is trying to find a marginal shift that signals the turning point where NAIRU is reached and the upward pressure from accelerating wages influences inflation. If we use his back-of-the-envelope approach (he has serious research on this), we can estimate that NAIRU may be as low as a 3% unemployment rate, given the present structure of the US labor force. (For a full description of the various US unemployment rates and the methods of data collection, see “How the Government Measures Unemployment,” Furthermore, as the national statistics gravitate toward this 3% NAIRU estimate, regional and state statistics are tending to confirm the trend. Great work on the state data is performed by Philippa Dunne and Doug Henwood. I suggest serious readers check out the October 4th edition of TLR on the Economy. If you are interested, send me an email with your contact information, and I will ask Philippa to send you a copy of that research.

We have taken Danny’s U-7 concept and developed some measures and estimates of the impact of the changes in the U-7 on things like the Consumer Price Index, average hourly wages, and JOLTS (the job openings portion of the labor data). What we are seeing in every series is a trend toward rising wages and rising inflation. It is hard to discern the exact month of acceleration in these series, but there seems to be some consistency. We will send any reader who gives us a snail-mail address a set of our U-7 charts. Researchers now have a road map if they want to develop their own statistics.

Let’s sum this up after we thank those journalists and friends and colleagues cited here. Please remember that anyone who is writing and publishing publicly is under repeated attack these days, as the Constitution’s First Amendment protections seem threatened by political forces unlike those we have seen in American history in recent decades.

We think the president’s attack on the Fed was wrong. It hurts his political party. It hurts the country. And it helped tank the markets. The Trump-Navarro US-China trade war is worsening, and markets don’t like it. Markets now fear that Trump has undone the beneficial effects of his repatriation policy, tax cuts, and deregulation initiative. What started out on a positive path is now a war between the two largest economies of the world. That war now seems to be intensifying. Remember: In a shooting war the guns are pointed at each other; in a trade war the guns are pointed inward. Nobody wins.

The warning on the saloon piano was apt. Don’t shoot the player who is doing his best. (And especially don’t try to shoot the player if it is Doc Holliday.)

Mr. President. You will do what you want. That is continually made very clear by your behavior. The country will determine who is loco. And history will report the results.

We are allocated toward domestic weights in our US ETF managed accounts. We have a cash reserve. We are in a correction.

Positions in portfolios can change at any time.

David R. Kotok
Chairman and Chief Investment Officer
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