“Wages Rise at Fastest Rate in Nearly a Decade”

That’s what The Wall Street Journal told us last week.

In October, the average worker earned 3.1% more than from this time last year. That’s the biggest increase in wages since the U.S. emerged from the Great Recession in 2009.

People aren’t just making more money… More people are working, too. Employers have added to their payrolls for 97 consecutive months.

On top of that, 82.3% of Americans between ages 25 and 54 (considered prime working age) have jobs—the most since 2010.

This is causing a worker shortage… In September, there were over 1 million more job openings than there were people unemployed.

Companies are competing hard for workers and paying more… Which is certainly good news for employees… But it will be bad news for one group of investors.

The Downside

Rising wages are good for workers. But they drive up the costs of doing business. On top of that, companies are seeing rising material costs:

  • Ford said rising steel prices cost it $1 billion.

  • Procter & Gamble saw a 50% jump in raw materials.

  • Colgate-Palmolive saw transportation costs rise 8%.

On Friday, the Producer Price Index (PPI) released its latest numbers. The index measures the prices domestic producers receive for their output. In October, the index rose 0.6% from September… the biggest monthly increase since 2012.

Over the past year in total, businesses had to pay 2.9% more for supplies than they did the year before.

And while these increases haven’t fully crept into the consumer inflation numbers yet, they will soon.

Companies have two choices: Either absorb the higher costs and make less money… or pass those costs along to customers.

From what I’ve heard on earnings calls, companies are leaning toward the second option. They’re preparing to raise prices, which means inflation is coming. And to combat that, interest rates will rise.

The Result of Rising Inflation

As inflation goes up, interest rates will need to rise as well. It’s just a natural occurrence in the financial markets.

Otherwise, investors won’t have any incentive to lend money to companies to expand. They’d lose money in real terms—which means they’d be better off spending that money now instead of saving it for later.

And expect the Federal Reserve to step in and raise rates, too. One of the Fed’s primary goals is to keep inflation around 2%.

Inflation is already at 2%… If it goes higher—and it could go a lot higher from here—the Fed will raise rates to tamp it down.

Fed Chair Jerome Powell often says what’s on his mind. In an early-October interview with CNBC, he said interest rates are “a long way from neutral.”

A neutral interest rate is one the Fed believes will neither help nor hurt the economy.

Investors took his words to mean interest rates are going a lot higher…

Rising Rates Will Lead to Income Exodus

Both inflation and rising interest rates are bad news for one group of investors in particular: bondholders.

Bonds are inversely related to interest rates. So as rates go up, bond prices go down.

In the Daily, we’ve been warning readers for months that rising rates will crush bond prices—especially long-dated bonds and bond funds. We call this Income Exodus.

If you must own bonds, stick to bonds that mature in two years or less. And consider staying invested in stocks while the economy remains strong.

There are two sectors you should keep an eye on: financials and consumer discretionary…

Employed people generally pay back their loans… and rising interest rates will help banks’ bottom lines, so expect financials to do well. And people spend more when the paychecks are coming in, so consumer discretionary should rise, too.

Regards,

Nick Rokke
Analyst, The Palm Beach Daily

MAILBAG

One reader thinks our bet on the earnings trifecta came a bit too late…

From Jonathan M.: Hi, Nick. Your article about the earnings “trifecta” was wonderful. Your insight into the four stocks was great. However, a quick look at the October stock charts of those companies shows that it’s all post-facto. Share that info in September, and the Daily has value. My insight.

Nick’s Reply: Jonathan, you’re right. The charts will reflect data that is “post-facto” (or after the fact). And that’s the beauty of the strategy I shared—it works after companies announce their earnings. That’s why it’s called the post-earnings announcement drift.

Stocks that complete the trifecta tend to drift higher over the next 90 days.

No one knows which companies will complete the trifecta before they announce earnings. Some people try guessing, but it’s a tough game.

Even if I had a crystal ball that told you to buy these companies before earnings, you’d probably be down. In fact, they are all down about 10% from their recent highs… even after earnings.

Right now, we can use the recent market volatility to buy these winning companies at discounts to where they traded just weeks ago.

Questions or comments for our editors? Send them to us right here…

IN CASE YOU MISSED IT…

You already know about President Trump’s trade war with China, but there’s another “war” going on.

Right now, the U.S. and China are in a high-stakes race to be the world leader in a radical new military technology… And so far, things aren’t going well for the U.S.

According to the Asia Times, “China is winning.” And unless the U.S. gets its act together, our technological superiority over China could come to an end.