Fasten your Seat Belts & Other Economic News

for the

Week Ending November 12 2021

Treasury yields rose significantly over the course of the week on the passing of the infrastructure plan and inflation concerns. The U.S. House of Representatives approved an infrastructure package already approved by the Senate that went on to President Biden to be signed into law. This caused traders to seek a more risk on approach on Monday, as yields rose materially.

Yields reversed themselves and dropped on Tuesday, despite U.S. wholesale inflation rising in October. Federal Reserve Chairman Jerome Powell had said the previous week that the Fed would be patient about raising interest rates, so investors shrugged off inflation concerns on Tuesday. However, those concerns were realized further on Wednesday as inflation surged 0.9% MoM and 6.2% YoY, compared to estimates of 0.6% and 5.9%, respectively.

Investors were not as sure that the Fed would be able to hold off a rate hike for as long as they expect as the chance of a rate hike by next June rose from 55% to 77% in one day, and yields soared. Yields rose materially again on Friday with the University of Michigan Consumer-Sentiment Index coming in at 66.8, compared to expectations of 72.5, the lowest since 2011. 

Inflation

U.S. CPI (inflation) saw the biggest YoY jump since 1990, with prices rising 6.2% in October from the year ago period. On a monthly basis, prices increased 0.9% versus estimates of 0.6%. Core inflation ran at a 4.6% pace, and shelter costs rose 3.5% YoY, pointing to concerns that inflation may be more persistent than policymakers think. There are several reasons for this and most of this is because of housing prices increasing as landlords try to recover losses during the pandemic. Energy was also a contributor as the price of oil has basically doubled, lastly are supply chain issues, the cost of shipping a container of good from China increase 10-fold due to increased demand from consumers. The big question will be how much over buying has been done by companies and will be left with product on their shelves which will then be dumped when demand shifts.

In addition, wholesale prices, as measured by the PPI, swelled 8.6% YoY. Consumer sentiment took another hit, falling to a 10- year low of 66.8 in early November as Americans’ expected inflation rate increased to 4.9% for the next year. This of course is due to the media sensationalizing the numbers and creating a self-fulfilling prophecy. Lastly 4.4 million Americans left their jobs last month a record number considering they have not replaced or look like they will be in the near future, so it appears a shift is happening and time will tell how Americans will change their lifestyles  

Fasten Your Seat belts

Inflation will not be the cause of an economic slowdown. It will be due to poor decision making by both the Fed and the current administration. We do not see much of an out from the poor decision made in the past and there has to be a consequence. If a business owner makes bad decisions with respect to the operation of his company, the ultimate price is to go out of business and lose his investment and savings. Politicians may lose the election but it’s the public, mostly the middle-class families that pay the price.  We do not see a strong economy in the near future, so if you’re a business owner, you might want to run a tighter operation and streamline your expenses.

As mentioned above the major market news for last week was the overheated inflation numbers. Last Wednesday’s CPI release showed a three-decade high level of inflation (6.2% Y/Y; 0.9% M/M). The data surprised to the upside, especially after Tuesday’s rather benign PPI release. The core metric, which excludes food and energy, increased by 0.4% M/M and 4.6% Y/Y. Excluding rent and auto prices, the core (which already excludes food and energy) rose 0.2%, which is not very comforting for consumers who pay rent, eat, and drive. 

Goods, Services and Poor Decisions

When looking at the indexes of consumption expenditures and brake it- down between goods and services, starting back in 2012 at 100 for each. We saw a dramatic movement away from goods and toward services through the ensuing eight years. Services index grew +2.5 index points while goods declined by more than -6. 

Then the pandemic arrived and things flipped. The goods index rapidly increased by +15 index points while services fell -7.5 (Keep in mind that the “non-essential” service economy was shuttered by government fiat in early 2020). Reopening has reduced the 22.5 index point gap to +7.5 index points, still in favor of goods but a far cry from the pre-pandemic +9 index point gap in favor of services.

We are of the view that much of today’s inflation is due to government policies: all bad decisions have some impact on the whole economy and it just so happens to rearing its ugly head at the moment

·      The shut-downs, distancing requirements, and vaccine mandates, have caused supply-chain issues;

·      As mentioned earlier, the service sector shut-downs also caused a huge jump in the demand for goods

·      At the same time, the federal government sent helicopter money to most U.S. households and implemented generous and long-lasting unemployment benefits which both increased demand for goods and, to this day, have impacted labor supply

Basic economics says when reduction in supply is met with rising demand (the shift from services to goods and to free money), prices go up.

Looking at the services sector alone, prices rose 0.6% M/M in October and by 3.6% Y/Y. Elevated – yes, but much more well-behaved than the prices of many consumer goods. There has been a pivot back toward services now that the economy has been allowed to reopen. If this continues, the supply chain issues will begin to heal but it will not happen over night

Energy & Rents

We do not expect significant reductions in energy (gasoline) prices, as much of this issue has to do with policies directed at green energy. Green energy is in its infancy and the cost to implement this new technology, so to make it worthwhile the price of oil needs to be high to justify the investment. But make no mistake green energy will not start off at a bargain and consumers will struggle with the shift to make it affordable for most  

Housing specifically rents are an inflation area that is also likely to remain elevated. This makes up 30% of the CPI. Why will it remain high? We believe that landlords will need to recoup losses.  Remember the government put moratoriums on evictions and foreclosures, and landlords had significant rent collection issues for more than a year. Now that the moratoriums have ended, they are demanding back-rent, and are raising rent to make up for a year of significantly reduced cash flow. 

A good portion of the rent calculation in the CPI is a number that is imputed (not collected directly) by government statisticians called Owners’ Equivalent Rent (OER). Basically, OER represents the rental value of an owner-occupied home. During the pandemic many apartments were vacated by tenants, Cities like NYC and Chicago were like ghost towns which basically artificially held down the CPI increases. But, no longer. OER rose 0.4% in October, a repeat of September’s rise. This is nearly a 5% annual rate of increase. And, it looks like it will get worse and pose a headache for policymakers in the near-term. 

There has been a significant rise in multi-family housing starts over the past several months, and we also note that single-family homes are being increasingly purchased by REITs and hedge-funds with the intent to rent. This is another contributor to housing prices. We think that the increase in in supply from the new developments will eventually quell. But in the meantime, we will see a few qtrs. Of increasing cost to housing /rent

Labor Markets

From an unemployment standpoint, the labor markets have continued to heal, trending toward their pre-pandemic “norms.” Continuing Unemployment Claims (CCs), at 2.57 million (week of Oct. 23) are now approaching the 2.11 pre-pandemic level. However, we had 4.4 million workers leave their jobs in September and this signals a shift in the consumers lifestyle choices. These jobs do not seem to have been replaced just yet. If they leave the workforce permanently then we will see more outflows in the market dollars.  Source Bob Barone Ph’D Economist

Other Economic Information

Besides the rapid rise in gasoline prices, which is usually a harbinger of an upcoming slump in consumption, other information continues to warn of economic slowing:

• The October NY Fed Survey of Consumer Expectations showed a rise in the probability of debt delinquency to 11.2% of the sample vs. 9.9% in September’s survey.
• China’s economy continues to weaken due to deleveraging taking place in their residential sector and a continuation of energy issues for large power consuming industries.
• As we pointed out in last week’s blog, the Baltic Dry Index is down more than 50% from its early October peak. This is an index of shipments of bulk materials (no containers) (e.g., iron ore). While this is most likely a function of a slowing China, it still has worldwide business and inflation implications.
• The University of Michigan’s Consumer Sentiment Index, historically a good leading indicator of U.S. consumption, continued its plunge in November. The preliminary reading fell to 66.8 (vs. 71.1 in Oct.). As seen from the chart, the last time the reading was this low was during the Great Recession. We suspect that much of the lost confidence derives from the rapid rise in gasoline prices and the daily inflation banter from the financial media.

The scheduled ending for COP26 came and went on Friday, with no final decision in sight. Countries are still haggling over a possible commitment to phase out coal and fossil-fuel subsidies; financing for those suffering most from climate change; a framework for a global carbon market; and a way to judge whether countries are meeting their targets.

As mentioned earlier American consumers are getting gloomier about the economy. Concerns over rampant inflation dragged the University of Michigan’s consumer-sentiment index down to its lowest level in a decade in early November. Separately, 4.4m American workers quit their jobs in September, the highest number since records began. Demand for labor remains high. There were 10.4m job openings at the end of September.

Utilities Sectors

The Utilities sector includes electric, gas and water utilities; independent power producers and energy traders; and companies that produce electricity using renewable sources (e.g., solar, wind, hydropower).

The Utilities sector has tended to perform relatively better when concerns about slowing economic growth resurface, and to underperform when those worries fade. That’s partly because of the sector’s traditional defensive nature and steady revenues—people need water, gas and electric services during all phases of the business cycle.

Meanwhile, the low interest rates that typically come with a weak economy provide cheap funding for the large capital expenditures required in this industry.

However, while interest rates are low from a historical perspective, they are expected to rise as the economy continues to expand and inflation rises. On the flip side, there is the potential for a renewed decline in the economy to push rates even lower, or there could be significant government funding to Utilities as part of clean-energy initiatives that would benefit the sector’s profit outlook.

Positives for the sector:

Generally stable revenues;

Investors often turn to utilities for dividend income when prevailing interest rates are low.

Low yields provide low funding costs for this capital-intensive sector.

Negatives for the sector:

Interest rates are expected to recover from recent decline.

Economic recovery makes the sector less attractive, relative to other sectors.

Poor momentum

Weak forward earnings growth

Risks for the sector:

Uncertainty regarding potential clean-energy legislative funding;

Much higher interest rates due to unexpected rise in inflation.

The Week Ahead

This week the focus shifts to how inflation, supply chain issues, and pandemic-related disruptions are affecting consumer spending and industrial production. In the U.S., the economic calendar kicks off with the Empire State Manufacturing Index today, followed by October retail sales and industrial production numbers on Tuesday. Housing starts drop Wednesday, with the Philly Fed Manufacturing Index on Thursday. There are a number of speeches from FOMC members throughout the week, and it’s becoming clear that investors are in disagreement regarding both fiscal and monetary policy. The “transitory” argument is wearing thin. After the Bank of England surprised markets last week by holding rates steady, UK CPI is expected to show further acceleration, while a labor market update and retail sales report provide additional insight for the BOE. Other events of note include EU Flash GDP for Q3, Canadian CPI and retail sales, and Germany’s PPI to close out the week

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/