Economic Monitor: Is the Party Over?
BY: Mark Drachenberg
Yogi Berra is one of the most famous players in baseball history, but not solely for his skills behind the plate. Yogi was a quote machine whose turns of phrases often left people scratching their heads, doubled over in laughter, or both. One of his more famous quips was, “You can observe a lot by just watching.” Well, yes, that’s true, and it’s a great reminder for us right now, as we navigate the economic environment in which we live.
Volatility seems to be back, as is a rising sense of uncertainty over what the future holds. Recently, Covid’s Omicron variant sent traders, politicians, and economists off on a frantic search for answers. Equities sank, politicians strategized on new (old?) measures to combat it, and economists warned of potential dangers to the economy, if handled poorly. “It’s like déjà vu all over again,” as Yogi said. Add to the mix the highest level of inflation in 30-plus years, and the sentiment is understandable.
Let’s dive in and try to make some sense of what we’ve been seeing.
Financial Markets
Our topsy-turvy fall went haywire in November. The month saw equity markets reach new heights, only to face a rocky final week. Bond markets felt the strain of inflation and the potential for rising interest rates, only to finish the month with a slight rally, as the yield curve flattened somewhat. Earnings have stayed strong, and other data generally support a strong economy.
The downers continue to be unemployment issues, inflation, and the new Covid variant. Chiming in, the Fed and politicians in Washington have only added more uncertainty to the mix. Every major equity index fell during November except for the NASDAQ, which squeaked out a 0.33% gain. The Dow shed 3.50% in November, while the S&P 500 gave back 0.69%. The S&P 400 (mid-cap stocks) and the S&P 600 (small-cap stocks) lost 2.94% and 2.29%, respectively. The equal-weighted S&P 500 index (less reliant on the performance of a few of the largest stocks) and international stocks (generally more value-oriented) both gave back some ground, losing a respective 2.54% and 4.79%.
A bright spot was the U.S. Aggregate Bond index, which gained 0.30% on the month. For a while now, we’ve been talking about the possibility of a correction (a loss of 10% or more), and while it seems like we might be heading into one right now, “It ain’t over till it’s over!,” as Yogi would say. What is definitely happening, though, is market valuations are continuing to come down, earnings remain strong, and the Fed is still cooperating, all of which should bode well for the markets as we finish out this year and head into next.
Economy
Inflation ran at 6.8% in November – the highest rate in nearly 40 years – and doesn’t appear to be slowing down, even as supply chains begin to loosen a bit. Higher input costs for manufacturers mean, for the time being at least, that higher prices are stickier than originally thought. Unemployment is trending lower, and that is both a positive and a negative for the economy. On the plus side, there are plenty of available jobs and wages are increasing; on the downside, fewer people are looking for work. Ultimately, we look to be headed back to where we were before the pandemic – slower growth, due in part to lower productivity gains, due in part to a shortage of labor.
The new variant of the Covid virus, Omicron, spread fear through the markets when it was first reported. So far, however, it doesn’t appear to be as concerning as it initially did, but because the data is so new, any surprises will only add to the market’s volatility. From our perspective, the biggest concern is inflation. As Yogi once lamented, “A nickel ain’t worth a dime anymore!” The fear is that, if nothing is done to combat inflation, it will become a vicious cycle: rising wages will lead to higher costs, which will lead to higher wages, leading to higher costs, and on and on. Those who remember the late ‘70s/early ‘80s know that the result of this cycle is not pretty. Are we on that path? At this point, we don’t know, but we do know that, maybe, “We made too many wrong mistakes,” as Yogi said.
Fed Watch
The Fed has its hands full, as it tries to steer the economy toward stable footing. Rising prices may be forcing the Fed’s hands to tighten sooner than planned. November saw the beginning of the tapering process in the Fed’s purchase of bonds, but that just means the rate of new purchases is slowing – it does nothing to reduce the size of the Fed’s balance sheet. The recent data, however, seems to have caused the Fed to reconsider the speed of both the tapering process and when it may raise rates.
Yogi once said, “When you come to a fork in the road, take it”; for the Fed, that fork is either continuing its easy-money policies or speeding up tapering and tightening to fend off inflation. It must choose, but one can understand the reluctance to take immediate and strong action. Data points to strong demand by consumers, as indicated by spending and a sharp increase in credit card applications. Slightly better manufacturing data and, perhaps, improving supply chains mean a strong economy, but will Omicron and rising prices stifle that demand at some point?
There’s an old adage that says “don’t fight the Fed” when it comes to investing, but Chairman Powell’s recent testimony, when questioned about the durability of inflation, has left many justifiably concerned.
“Well, first of all, the test that we’ve articulated, I think clearly has been met now. You’re absolutely right, inflation has run well above 2% for long enough that, if you look back a few years, inflation averages 2%. ... It was not the case going into this episode – it had been many years since we had inflation at 2%. So, I think the word ‘transitory’ has different meanings to different people. To many, it carries a sense of ‘short-lived.’ We tend to use it to mean that it won’t leave a permanent mark in the form of higher inflation. I think it’s probably a good time to retire that word and try to explain more clearly what we mean.”
To his last point, yes, it would be a good idea to explain what he means more clearly! Maybe he should have taken a page from Yogi’s playbook and said, “If you ask me anything I don’t know, I’m not going to answer.”
Outlook/Summary
Despite the pervasive uncertainty, the glass remains at least half-full. Inflation is running hot, but there are bright spots on the horizon. Supply chains are improving in some areas, holiday demand will ease, job openings are plentiful, earnings outlooks remain strong, and so far, at least, the new Covid variant appears less troublesome than initially thought.
Keeping a careful eye on the economy and markets is always a good thing and can lead to some great opportunities. With rates and energy prices going the way they are, financials, energy-related stocks, and industrials should do well, and there will likely be opportunities in technology (typically hit by rising rates) as well, especially after any pullback. To quote Yogi Berra one final time, “The future ain’t what it used to be!” This certainly will prove to be true – and here’s hoping it will be even better!
To discuss your portfolio, or any other issue you may have, please reach out to me directly or call the Wealth Management department of Lake Ridge Bank at (608) 826-3570. We look forward to speaking with you.