Equity markets finally responded on Thursday with some positivity, with the S&P 500 Index closing above the 50-day moving average for the first time September 16th. The index has spent the last 12 days below the 50-day moving average - the most number of days since the pandemic began in February of 2020. Now that the Fed is preparing for Tapering and yields have risen, the market is trying to figure out where the economy stands - as it would appear fundamentals matter once again. The Rolling Stones wrote the song, "I Can't Get No (Satisfaction)" in 1965 as a critique on relationships and modern culture.
A bit of trivia - Keith Richards first wrote the music to the song on an acoustic guitar in his sleep! That's right, the cassette tape has him playing the first chords, the sound of him dropping his guitar pick, then 40 minutes of him snoring! The lyrics to the song describe the confusion and exhaustion of trying to understand what society is trying to tell him. This is akin to what the market is experiencing. It's like waking up from an afternoon nap (no relation to Keith Richards' musical slumber) and trying to comprehend what time of day it is. The lyrics are applicable to current markets and societal ills:
"When I'm driving in my car, and that man comes on the radio,
And he's telling me more and more about some useless information.
Supposed to fire my imagination. I can't get no...oh no, no, no!"
Here's what we're seeing so far this week in an action-packed Musings...
Now That Fundamentals Matter Again... The markets have awoken from the slumber of constant Fed stimulus to question where the economy will go from here. All the talk lately is that growth is slowing and we're headed toward stagflation. That is not our view, nor is it the view of Goldman Sachs. David Kostin, chief U.S. strategist at Goldman, stated this week, "Stagflation is not our economists' base case expectation." The concerns are arising from the shipping bottlenecks and labor shortages (more on those two issues later). What we have to remember is that Tapering would not be set to begin if the Fed thought that it would completely derail the economy. Inflation is another concern, but one, quite frankly, that lies at the feet of bad public policy. The U.S. economy is a behemoth - a Titanic, if you will. Just as the Titanic's tiny rudder couldn't prevent it from avoiding the iceberg (along with human error), the economy can't avoid the considerable policy mistakes of COVID. You can't shut the economy down then expect it to return to normal like turning a switch off, then on. Neither the former administration, nor the current administration had a plan to re-open the economy without disruption. If these disruptions are not solved in the next few months, we could face runaway inflation.
Labor Market Could Be Showing Signs of Healing. This week, two key metrics of the labor market - Weekly Jobless Claims and Continued Claims - showed some positive progress.
Continued Claims, those people who have been on unemployment benefits for more than one week, fell for the 3rd consecutive week and claims are down 10.8% since August 14th. This is important as two weeks after the 14th, extended pandemic unemployment benefits officially ended. While this is a good start, we would like to see a considerable drop in Continued Claims over the next several weeks to see some progress on the labor shortage front.
At the same time, Weekly Jobless Claims this week dropped below 300,000 for the first time since the pandemic began in February of 2020. If we consider the 40-month average preceding February of 2020, current claims are within 80,000 of that 40-month average. With the unemployment rate dropping to 4.8%, according to last week's Jobs Report, the case for stagflation is not a strong one at the moment. If the labor shortage can be solved, the shipping bottleneck and supply chain issues can be slowly uncoupled.
Speaking of Shipping... There is some positive news on the shipping bottleneck. First, President Biden has vowed to keep the key ports open 24hrs in order to offload the number of ships anchored off both coasts. While this will allow said ships to depart for other ports to pick up more goods, it does not solve the problems associated with the ports and logistics of transporting goods offloaded at the ports. California is a state that has implemented strict EPA guidelines that prevent 18-wheelers that are 10yrs or older from being used at the ports to transport goods. This is adding to the bottleneck by keeping more trucks from transporting containers from the shipping yards. In addition, due to the strict COVID mandates in California, the crews on these massive container ships must quarantine for 2 weeks before being allowed to leave the ships, adding to delays (more bad policies, more bad consequences). And, while we're on the subject of bad policies, we've just learned that Secretary of Transportation, Pete Buttigieg, has secretly been on "paid leave" as this shipping crisis was unfolding. I guess "me time" comes before the country's needs.
Second, while there were 70+ ships anchored off the Long Beach port, that has dropped slightly to 60+ ships. If the containers can get loaded onto 18-wheel trucks, this could help some of the supply shortages being noted around the country.
Third, we've now seen the first decline in the Global Baltic Dry Shipping Rate Index in quite some time. The index peaked on October 7th at 5,650. The index has dropped 4 consecutive days to a value of 5,062 (or, -10%). That's not a massive drop, but a move in the right direction. We'll see if that trend continues as it will certainly have a directly impact on inflation.
Speaking of Inflation... The publication of PPI and CPI this week probably didn't ease the concerns of those who have been squarely in the "transitory" inflation camp. In July and August, the Consumer Price Index seemed to ease slightly from the considerable increase in June.
September's print of CPI came in higher than expected (+0.4% vs 0.3%). Conversely, the Producer Price Index came in slightly less than expected for September (+0.5% vs 0.6%). Two issues of concern - first, we're not seeing any significant slowing of inflation; and second, producers appear to be absorbing the majority of increased costs as opposed to passing those along to the consumer.
How long do we expect that to continue? At some point, producers will have to pass those costs onto the consumer when profit margins are squeezed by rising production costs. We're even seeing private companies, such as Home Depot & Walmart, charter their own containerships in order to get timely delivery of goods. Meanwhile, the "transitory" inflationary costs for logistics continue to be a problem. Rail transportation of goods has risen 6.8% from a year ago. Air freight costs rose 2.3% in September alone (up 5.2% year-over-year). Transportation of goods by 18-wheeler is up a whopping 15% year-over-year! To top it off, Warehousing costs for stage three goods is up 10.3% versus one year ago. In contrast, last week's Labor Report showed that the average workers earnings are up only 4.7% year-over-year.
The latest Cost of Living Adjustment (COLA) to Social Security for next year was recently announced to be +5.9%, the largest one-year increase since 1982 (side note: 1982's COLA was announced during 1981 when inflation was 10.4%. The year prior, 1980, inflation had peaked at 13.5%) Yet, when we step back and compare the increase in wages and social security payments, they pale in comparison to rising inflation. Key items such as gas, commodities, and housing have seen price increases anywhere from 3 to 19 times higher than the increase in wages or social security. Oh, and by the way, the government needs to cease and desist with the publication of "Core CPI." Core CPI measures consumer prices minus energy and food. Really?! There are 276 million registered cars in the United States. There are 75 million children in the U.S. That means there is basically a car for each eligible person in the country. Every human being needs food to survive. So, to publish Core CPI is a useless exercise! The fact is that inflation is here to stay and investors need to adjust accordingly.
Where Can Investors Get "Satisfaction"? Now that I've laid out all of the challenges ahead, what about the good news, you ask? It would seem that the only real game in town is equities. As I previously noted, the beginning of tapering means the economy should be able to stand on its own two feet.
Also, the fourth quarter is usually a good quarter to be invested. Since 1950, the fourth quarter provided the best returns, besting all three other quarter by at least 187 basis points, on average. Since 2010, the fourth quarter beat the other quarters by at least 200 basis points, on average. What about this year? Well, if tapering is to begin, that means that interest rates are likely on the rise - at least in the immediate future. Also, with inflation rising, that means that the "real" return (inflation-adjusted) is negative on bonds. Other than equities and some alternative strategies, there's no where else to go with inflation rising. This situation should set up nicely for stocks. That doesn't mean that stocks will go straight up from here, but it does mean, on a comparative basis, stocks should be a part of your portfolio.
Despite the negative news and the concerns going forward, the overall economic picture is still stable, for now. According to the Fed's National Financial Conditions Index, the markets are functioning normally. Conditions continue to be "loose" and that bodes well for equities. If the S&P 500 Index closes above the 50-day moving average again today, that could set up a decent scenario for stocks to finish out the year on a positive note.
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