Markets Upbeat Despite Headwinds
Markets are performing well in the early weeks of the 4th quarter. Historically speaking, equity markets tend to have their strongest performance of the year during the 4th quarter (+4.03% avg. return vs +1.69% avg. return for all other quarters). Yet, there are multiple headwinds facing future growth - shipping backlogs, labor shortages, and inflation. The U.S. consumer has remained resilient so far, but how long that continues remains to be seen.
This week's musings are inspired by the heroes who helped us during the pandemic and are now being discarded by terrible policy decisions. Last year, publications around the world were cheering the work done by these heroes. Today, not so much.
One of my favorite heroes is Superman, who is also falling victim to being rewritten into a different form. If you're interested in the true origin of the comic superhero, check out the story here. History can't be rewritten - it is what it is. Consumer spending, inflation, and supply & demand are concepts that can be seen in real-time data. Inflation, while good coming out of a recession, can also lead to a recession. The definition of inflation can't be rewritten, despite the best efforts of policymakers. Let's dive into all that we're seeing this week...
It's Not Supply That's The Problem, But Demand? Policymakers are trying to spin a yarn about supply and demand. White House Press Secretary Jen Psaki, when asked about the shipping bottleneck at the ports, stated that the backlog at US ports is because more goods are being ordered. "People have more money and their wages are up," she said. Factually, she is correct - people do generally have more money and wages are up overall. However, that's not why there is a bottleneck in shipping. Companies have this "strange" desire to make more profits so that their value increases, shareholders make more money, and the company thrives. This happens by selling more goods, especially when consumer demand is high. They can't make more profits right now because goods are not getting into the hands of consumers. I recently tried to order a set of golf clubs for my teenager. The website showed the clubs "in stock." Yet, two weeks after I placed my order, the seller notified me that the clubs were now "back ordered" and would not be available until 2022. I promptly cancelled my order. That's a small example of what's happening in the shipping bottleneck. You've all probably experienced a similar situation in the last few months.
Consumers have more money in their bank accounts because we shut everything down in March of last year and the government subsidized people's wages with stimulus.
The current savings rate is 9.4%, which is almost 300 basis points above the historical average. The savings rate reached 33.8% in April of last year, which was the highest level since the 1980s. Now that consumers actually have money to spend, there aren't enough goods to purchase.
Funny thing about our society today, there is a camera phone virtually everywhere. You can capture an image or a video in real-time and share it on social media around the world instantaneously. There are pictures of actual container ships anchored off the Long Beach port and shipping containers sitting in the port with no one to transport them. This has nothing to do with consumer demand. In fact, the Fed's own Beige Book of economic conditions for October points to steady consumer spending, but higher prices due to "product scarcity resulting from supply chain bottlenecks."
The ports are operating at 60-70% capacity, despite being open 24hrs/day. One report showed that zero requests to utilize the newly implemented red-eye shift were made by cargo owners since last Wednesday. Local warehouses are 98% full, so there's no where to take the containers to be emptied. In addition, there are not enough workers to offload at the ports, nor transport via railways or trucks. So, to blame consumers and demand for the shipping bottleneck is ignorant at best, mendacious at worst.
Inflation Is Here To Stay. While demand and wages are up, they are not keeping pace with inflation. Wages are up 4.6% year-over-year, but gas at the pump is up 57.5%.
The price of beef is up 20.6%. The price of sugar is up 30.1% the last 12 months. The price of corn is up 28.1% year-over-year. As I type this report, I'm ordering my typical lunch consisting of a deli sandwich with chips and a drink. This time last year, that cost me $14.86. Today, it costs me $21.79 (an increase of 46%). I can tell you this, my wages haven't gone up 46% in the last year - have yours? Each month, Deutsche Bank takes a survey of top economists and top investors.
In April, the top concern posing the biggest risk to the market among those surveyed was new COVID variants. Today, the largest concern is higher than expected inflation / bond yields. Second on the list is central bank policy error (likely tied to the 1st concern). Third on the list was fading economic growth. This is the 1st time since April that COVID was not in the top 3 lists of concerns. I guess we can look at this one of two ways - a) COVID has receded and is no longer a top concern, or b) inflation and bond yields have risen within the last few months to overtake COVID as a primary concern.
What Are Investors To Do? The good news is that the headwinds do not seem to be harming equity returns for now. Since the end of the 3rd quarter, the S&P 500 Index is up nearly 5% and higher than 21% year-to-date. In fact, equities are almost the best game in town, other than Real Estate and Commodities. If we break down the return of different asset classes and adjust for inflation, bonds are in negative territory.
After inflation (real return) equities are still up more than 28% over the trailing 12 months. TIPs (Treasury Inflation-Protected Securities) are one of the few bond asset classes that are positive over the last year, inflation-adjusted. Real Estate has greater than a 30% return from 1 year ago, after accounting for inflation. So, while equity valuations are stretched in some asset classes, it's still one of the best asset classes to own for combating inflation.
In terms of real-time data, consumer demand hasn't changed substantially (see Beige Book), despite the picture policymakers might try to paint. Retail Sales are up just 0.9% from one year ago. Good, but fairly steady. Meanwhile, Consumer Sentiment, as measured by the University of Michigan, is down 5.1% from one year ago. The reason the shipping bottleneck is such a concern is that the U.S. consumer is 2/3 of GDP. If the average consumer were to follow my lead on my son's golf clubs and start cancelling orders or waiting until the shipping crisis resolves itself, discretionary purchases could significantly decline. This is why the market is concerned about future growth.
One of the key issues affecting the shipping bottleneck is the labor shortage. There was some good news on that front yesterday as both Weekly Jobless Claims and Continued Claims declined.
Continued Claims dropped another 122,000 this past week and have declined by more than 14% since the end of extended pandemic unemployment benefits. Weekly Jobless Claims were down to 290,000 and have declined for 3 consecutive weeks. While the news is good, we need to see further progress and more jobs added, especially in the transportation and warehousing industries.