With Q2 S&P 500 earnings growth at 26.58%, core PCE inflation only at 2%, and small business optimism at the highest level in the 45-year history of the NFIB survey, there’s not much reason to be bearish on equities in the intermediate term. The biggest concern in the next few months is a potential trade war. FactSet determined in its stress test that U.S stocks could lose between 10.83% and 21.88% if there is a trade war. Just because these estimates are precise, doesn’t mean they will be accurate to the nearest hundredths place or even to the nearest percentage point.

Inflation Will End The Cycle: The Question Is When

In this article, we’ll leave out the trade skirmish drama and discuss how close the economy is to the end of this expansion. The baseball analogy where the economy is in a certain inning is overused. It’s better to just go with whether the economy is early cycle, mid-cycle, or late cycle. If the labor market is close to being filled, the economy is late cycle. If it has a couple more years of improvement, the economy is mid-cycle. Those are the two options.

Inflation usually catalyzes the end of the business cycle. Ever since the August BLS report showed average hourly earnings growth of 2.9% and average weekly earnings growth of 3.2%, the breakeven inflation rate and treasury yields have been increasing.

We will see the effect nominal wage growth had on CPI and PCE in the coming days. If inflation remains modest as expected, real wage growth will accelerate. However, the concern for the economy is when the labor market loses its slack, inflation will have to increase. The situation isn’t problematic for the Fed yet because the curve didn’t flatten after the BLS report. The situation can change in 2019 as wage growth pressure intensifies.

How Full Is The Labor Market?

The labor market isn’t filled as of August because 201,000 jobs were added which is almost double the amount of jobs necessary to keep up with population growth. The key question is when the labor market will become full. That will spell the beginning of the end of the expansion. The prime age labor force participation rate is at 82%. It peaked at 83.4% in the early 2000s expansion and at 84.6% in the 1990s expansion.