A Bipolar or Disconnected Market & Other Economic News

for the Week Ending Dec 17th 2021

Treasury yields fell across the board as investors digested the implications over omicron variant concerns, the 10-yr slipped to 1.4%. Inflation continues to be a thorn in the central bank’s side, with U.S. PPI increasing at a record pace in November, up 9.6% YoY and 0.8% MoM.

Other economic data was mixed. U.S. retail sales rose modestly in November, but Black Friday sales were weaker than expected. Many may think it was hampered by supply shortages, but we think the issue is that most of the shopping was done early as fears of shortages force consumers to buy what they could in advance of the holidays buying season.

Regional manufacturing data showed robust conditions in New York but slowing growth in Philadelphia. U.S. flash PMIs revealed that early December business activity expanded at a slower pace, with the composite index edging down to 56.9 from 57.2.

Industrial production rose to the highest level in over two years, and housing starts increased 12% MoM in November.

Overseas, the Bank of England became the first to raise rates with inflation hitting 10-year highs. The ECB further reduced its bond purchases but asserted sustained monetary policy support while keeping rates unchanged. China’s economic activity lost pace in November amid the ongoing property slump, although factory production rose as the energy crisis eased. 

Is the market disconnected

Is the stock market disconnected from the economy? Throughout history, there have always been correlations you would expect to hold constant between the market, consumer confidence, and the economy. But, after 13 years of an artificially suppressed (zero) interest rate policy, massive amounts of liquidity, and abundant financial support, it seems the financial markets have become detached from reality.

There are several factors that are contributing to this currently level of market exuberance. One is the low rate of intertest, with rates so low the present value of forward earning of companies is higher since they are barely discounted, hence over valuing the price of the stock. In addition, the low interest rates leave very little returns for those that would normally place a larger percentage of assets in their portfolio in fixed income instruments. So, more funds are flowing to equities. Fixed income historically viewed as a conservative investment has been more volatile of late.

Second is the wave of stock buy backs, with debt so cheap & many companies holding so much cash, not to mentioned that executive compensation is often tied to stock performance reducing the amount of stock available in the market drives up prices by reducing supply. For Corporations it often makes sense since dividends are not being paid on those shares. Then we have the phenomenon of the index & ETF fund and quasi passive strategy that is fully invested at all times and sends buy orders on those stocks held in the fund.

The combination of these influences has led to distorted valuations/pricing of stocks.

Historically, at the peak of every major market cycle, investor exuberance runs amok. Notably, at the peak of each cycle, investors believed “this time will be different,” whether due to some new wave of technology or cosmic intervention.

However, while current valuations may reflect investor “greed,” other measures better represent the disconnect between the market and fundamental realities.

Market Vs. Economic Growth

One of the most fundamental disconnects currently is between stocks and the economy. As Warren Buffet has stated when the valuation of the market is significantly higher than the GDP, there’s a problem Historically when stocks have deviated from the underlying economy, the eventual result is lower stock prices. Over time, there has always been a close relationship between the economy, earnings, and asset prices.

Since 1947, earnings per share have grown at 6.32%, while the economy has expanded by 6.30% annually. That close relationship in growth rates is logical given the significant role that consumer spending has in the GDP equation.

While stock prices can deviate from immediate activity, reversions to actual economic growth eventually occur. Such is because corporate earnings are a function of consumptive spending, corporate investments, imports, and exports. 

Stocks are not the economy

When the market disconnects from underlying economic activity its usually a result of emotional decisions behavioral biases.  Over the last decade, as successive rounds of monetary interventions led investors to believe “this time is different.” But investors have also been conditioned to believe the Government will step in. to save the day. Look at the sectors that performed the best during the pandemic. CEO’s also get caught up with the narrative and over stated their forecasting numbers. Eventually there is disappointment and prices come back to reality.  

Just remember that fundamentals never play “catch up” to stock prices. Stock prices will go back to match the fundamentals. Earnings cannot live in isolation from the economy.

It would be healthy if you didn’t dismiss the fact that markets can and do, deviate from long-term earnings. Historically, such deviations don’t work out well for overly “bullish” investors. The correlation is more evident when looking at the market versus the ratio of corporate profits to GDP.

The Feds intervention into the financial markets has outsized the growth on the markets and it will not continue. The reality is that the supports that drove the economic recovery will not support an ongoing economic expansion. One is self-sustaining organic growth from productive activity, and the other is not.

The risk of disappointment is high, so are the costs of being ignorant to the dangers.



Where are Americans feeling Inflation the Most?

Yes, we still think inflation is transitory and we believe that the numbers will recede in 2022. The media has made inflation a headline event for the last several months, Year over Year Month over Month numbers have sent the message loud and clear and Fed chair Powell has caved to political & media pressure to change his position, But we have not.

Rising inflation is hitting the wallets of many Americans. No question compared to 2022 prices The cost of food, gas and rent is where many are feeling it most. But why?

Over the past year, the median cost of rent has risen by nearly 20% in a handful of areas including Phoenix, Tampa, Fla., and Boise, Idaho. The average rent for a one-bedroom apartment in Sarasota, Fla., for example, is $2,004 a month—a 40% increase compared with the previous year. (this according to rental listing site Zumper). But not compared top 2019 prices. As we have mentioned in past newsletters 2020 was an anomaly with huge inventory of vacancies.

There are many factors are driving the rent surge now including a short supply of housing inventory. But this supply is based on wants more than needs and surely dependent on area. There is a deluge of renters who huddled with family members early on in the pandemic but are now driving demand for dwellings. Landlords, meanwhile, are just trying to recoup losses from the pandemic. You didn’t have to be a rocket scientist to figure out that rent would become a financial hardship for many Americans once the pandemic subsided. We believe that the challenges many are facing right now are simply the fault of the U.S. Government and the policies they created and enforced.

But this is not just on the Government. It also comes down to individual responsibility. Those individuals that lived in congested cities vacated those apartments in droves to move to more open space. Landlords (Not major Corporations) were left hanging and for those tenants that stayed many decided not to pay rent and to use the money Uncle Sam gave them to buy discretionary items. The Consumer Discretionary Sector of the S&P 500 Index delivered all time high returns as those businesses thrived during the pandemic and landlords suffered. It’s payback time

Those priced out of the hot housing market are pushing into rentals more single-family homes.

Urban areas such as NYC and Chicago have more inhabitants in surrounding suburbs but we believe this will reverse soon.

But for those renters that need to cope with higher rates they will need put less into savings & make more-drastic life changes such as moving to a more-stable rental area, if they can work from home or commute less. But the narrative is not clear. During the pandemic landlords with an excess supply in big Urban areas were giving apartments away with huge incentives. This lower base line is used in the calculations of today’s prices.

However, if you or a friend are impacted by the increase, here are a few thoughts we have on rent if you have to find a new place

The classic personal finance rule is to keep housing costs at around a third of your monthly take-home pay. That rule might be less relevant, or simply impossible, for those facing higher costs in metropolitan areas or rising rent markets. But we think this area will start to see some deflation in 2022 simply because there are going to be more multifamily homes available as that sector has seen larger developments than single family.

Rent should be thought of as part of your fixed bundled cost. If you are paying more on rent but less on other fixed expenses, such as utility bills or a car loan, then you can budget for higher rent. The important thing is to keep your fixed-cost expenses should not exceed more than half of your monthly take-home pay.

Once it gets past 50%, you start to see sometimes that people just don’t have enough left over for going out to eat and traveling, and that can lead to credit-card debt.

It’s a good idea to check median rent in your area. This way, you can gauge whether you are paying too much for the size and location of your place. Maybe you will need to make some compromises such as giving up location.

If you have no choice but to pay more for rent and your fixed expenses exceed the targeted 50% mark then you need to be disciplined enough to live leaner, less eating out, social activities that have higher cost associated with them, too often people live beyond their means and are unprepared to pivot quickly if catastrophe strikes.

Create a budget and live by it, making exceptions and taking it lightly will just result in longer terms issues that you might not be able to rebound from. But the good news is that next year rents will stabilize as we discuss below, more inventory in the current pipeline will add to choices.

A Bipolar Market

As soon as the Fed caved from constant market and media pressure to tighten, /speed-up of the QE “taper” and showed much more hawkish “dots” (the graphical plot of FOMC member views of where the Fed Funds rate will be in 2022, 23, and 24), the markets changed their tune. The bond gurus now see a softening economy, something we’ve seen for some time. Equity markets can’t seem to figure out what might happen next and have become volatile, and somewhat bipolar. 

Truth be told, a stealth equity sell-off has now been in place since late summer.  The Nasdaq NDAQ -1.3% is composed of more than 3000 tickers; 1300 (more than 43%) are in correction territory, i.e., down more than 10% from their peaks. The S&P 500 hit an all-time high on December 9 and the second highest historical close on December 14. The media bragged that the S&P had risen more than 25% YTD. Yet, 210 of the 500+ S&P 500 companies (42%) were also treading in correction terrain.

While the Fed’s “dot-plots” are calling for a 2.125% terminal Fed Funds rate in 2024, the futures markets, via real money wagers, have dialed back their view to 1.24%. In his post-meeting press conference, Fed Chair Powell gave a glowing picture of the state of the U.S. economy; surely the “kiss of death!” 

Certainly, some of his upbeat rhetoric can be viewed as political. After all, the Fed and the FOMC members are all appointed by the executive branch. Meanwhile, the models of Wall Street economists like David Rosenberg, and clearly the rate movements in the fixed income markets, are saying that a Fed Funds rate in excess of 1% will bring on recession. 

So far, the incoming data support the “softening” view: We have thought for a while that the “shortage” narrative, would pull holiday shopping forward. The November National Retail Federation’s survey found that 60% of holiday shoppers had begun their holiday purchases early. Thus, the +1.8% surge in Retail Sales in October (Seasonally Adjusted (SA)). Our view was that November Retail Sales would also be strong. (We were half right: +0.3%). Of note, November Department Store sales fell -5.4% and have contracted in two of the past three months. (And, it can’t be omicron, as that wasn’t even discovered until it appeared in South Africa on November 26, the day after Thanksgiving.) We believe that December sales will disappoint (on a SA basis), as will GDP. [It appears that Q4 GDP will be positive, but significantly lower than the 6.9% growth the Fed has penciled in) Remember we have more than 3 million people that left the workforce than means that there is less household money for gifts.

Real weekly earnings are down -2% Y/Y November’s reading was negative (-0.4%) and will likely remain so into 2022, until inflation cools. This means that consumers are able to purchase -2% fewer physical items than a year earlier (unless they dip into their savings). The fiscal giveaways are now in the rear-view mirror with the last (cash “advance” against the child-care income tax credit for 2021 taxes) set to end this month.

In our last blog, we commented about the weakness in November auto sales. The media has chalked that up to chip “shortages.” But U.S. auto factories have been producing again and domestic chip companies have also grown production. Chip shortages may have held back sales earlier in the year, but no longer. The real reason for the poor auto sales is demand satiation, as chronicled in the University of Michigan’s Consumer Sentiment Surveys, i.e., intentions to purchase autos at 40-year lows.

The Philly and Kansas City Feds released their manufacturing surveys this past week. The Philly headline fell by more than -60% (15.4 vs 39.0) while Kansas City’s was flat at 24. In both surveys, prices paid and received were lower as were backlogs; symptoms of easing inflationary pressures at the manufacturing level. Of further interest, capex plans tanked over the past couple months in both surveys; not a good sign for future growth.

Housing starts, surprised to the upside, but it was mainly in multi-family (+13% M/M; +37% Y/Y). Single-family starts turned up (+12% M/M), they are still down -1% Y/Y. For those worried about the impact of rents on the CPI (30% weight), just as the Fed gets ready to hike rates in mid-2022, we are likely to see disinflation in the rental market by then as the huge supply, currently in the pipeline, comes online.

Now there is China. The weakness there is reflected in its real estate sector, a large portion of China’s consumer net worth. So, the “wealth effect” will likely be at play in Chinese consumer behavior. Both the fall in the MSCI China Index (a large and mid-cap index of Chinese stocks) and the RE sector. A plunge in both since the Evergrande fiasco. The recent rapid fall in major commodity prices is connected directly to the weakness in China, the largest consumer and importer of commodities.

Data from the Eurozone (especially Germany) are downbeat, and the U.K. looks ripe to fall back into recession. Given all the above, especially slowing growth in China and worldwide, rapid 2022 domestic economic growth appears to be a pipe dream, perhaps driven by politics.

Labor Markets

We will start off here by observing that the media seems less and less concerned about labor shortages, and more and more about inflation. Perhaps it is because businesses are becoming less and less concerned. For example, in the Kansas City Fed Manufacturing Survey, employment concerns scored 18; they were 27 in November and 37 in October. 

Also note a spike in recent Initial Unemployment Claims (ICs) in the first two weeks of December. ICs are a proxy for new layoffs. Also of note is the concomitant rise in Continuing Unemployment Claims (CCs), after falling for much of the autumn, they took a giant leap upward post-Thanksgiving.

2022 expectations

We expect economic growth to slow in 2022 with China leading the way, Europe struggling, and the U.S. not far behind. Emerging market countries will also feel negative impacts from falling commodity prices. In the U.S., headline inflation will be falling, but “core” inflation, led by energy prices will be more stubborn than initially thought. This may prove problematic for the Fed. Central banks in many smaller countries, have already started raising rates. With recent rhetoric, the Fed has joined that crew (although still a long way from raising). Notable exceptions are the ECB (European Central Bank) and PBOC (Peoples Bank of China) both of which remain quite dovish and accommodative.

While the current official Fed position is that the economy is quite strong and interest rates could rise by mid-2022, we think that a weakening economy will moderate any rate increases, and we would be surprised if the Fed Funds rate gets much above 1% this cycle (by 2024). The fixed income markets appear to concur with this view.

Source Bob Barone Ph’D Economist and Forbes Contributor

The Week Ahead

Investors will likely be looking forward to a holiday breather, but we expect the coming week to continue the volatile path of the last several weeks. Now that the “transitory” description of inflation has been retired by the Fed, another update arrives Thursday with the U.S. Core PCE Price Index for November. The last trading day of the week will also feature the U.S. durable goods report, new home sales, revised consumer sentiment, and personal incomes and spending.

On Wednesday the third and final Q3 GDP number is expected to be unchanged at 2.1%, while consumer confidence may tick up from the prior month. On the international calendar, final Q3 GDP from the UK is anticipated to show that private spending remained sturdy. Canada is scheduled to release monthly retail sales and GDP figures. Other events of note include the German Bundesbank’s monthly report, minutes from the last RBA meeting, and EU consumer confidence data. U.S. markets will be closed Friday in observance of Christmas.

This article is provided by Gene Witt of  FourStar Wealth Advisors, LLC (“FourStar” or the “Firm”) for general informational purposes only. This information is not considered to be an offer to buy or sell any securities or investments. Investing involves the risk of loss and investors should be prepared to bear potential losses. Investments should only be made after thorough review with your investment advisor, considering all factors including personal goals, needs and risk tolerance. FourStar is a SEC registered investment adviser that maintains a principal place of business in the State of Illinois. The Firm may only transact business in those states in which it is notice filed or qualifies for a corresponding exemption from such requirements. For information about FourStar’s registration status and business operations, please consult the Firm’s Form ADV disclosure documents, the most recent versions of which are available on the SEC’s Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov/