Things You Can Be Thankful For...Even In A Bear Market
Jake shares some opportunities investors can be thankful for while in the midst of a bear market.
Five Things You Should Know
Insights for Investors
“It’s been the kind of year I’d be fine if I forgot…” – Ben Rector (The Best is Yet to Come)
The lyric above sums up the feelings of most equity investors this year. And while this year’s drawdown shouldn’t have caught investors completely by surprise after the fiscal “frat party” of 2020/2021 (see our commentary from 1/21/22), it does appear the associated bear market “hangover” may be to finally wearing off.
The key reason investors have to give “thanks” for this is that the inflation boogey-man appears to finally be receding (see guest article below), and equally important the Fed seems to be recognizing this new reality.
Earlier this week, prior to the release of the most recent Fed minutes, Federal Reserve Bank of San Francisco President/CEO Mary Daly spoke and her tone was “dovish” as she referenced recent inflation data as being a new “positive trend” and warned about the risks of over-tightening policy.
Then came the release of the minutes from the Fed’s November 2nd meeting which included more recognition of both of Daly’s points above.
The result is that odds have firmly shifted in favor of the Fed not only raising rates by only 50 basis points instead of 75 in December, but also that the hike may be their last of this cycle.
Why is this so important? Consider the next few charts and accompanying historical facts.
First, the S&P500 rises on average 15% in the 12 months after the Fed pauses, see chart below.
Second, stock markets typically bottom six months after peak inflation, which appears to have occurred in June (see accompanying charts).
Scott Grannis, former Chief Economist at noted fixed income manager Western Asset Management, along with current First Trust economist Brian Wesbury, are two economists whose insights and outlooks I hold in high regard.
Below is a great recent article from Scott Grannis discussing both the likelihood of the Fed nearing a pause in rate hikes, as well as the recent inflationary data that supports such a move.
Other related data he recently highlighted included “the unprecedented decline in the M2 money supply … the growth rate (of which) is now negative: over the past six months M2 is down at an annualized rate of -2%, and over the past 3 months it is down at a -4% annualized rate.”
While investors must accept volatility as an ever-present possibility on their journey, those choosing to fixate the recent difficulties and in so doing overlook the changing environment may miss a great longer-term opportunity.
We hope you are enjoying a wonderful weekend with your family, and this week’s messages give you some more things to be thankful for as we all look ahead.
All the best,
Tim and the team at TEN Capital
Near-Term Fed Pivot Almost Guaranteed by Scott Grannis
The release this morning of October Producer Price indices brings yet more evidence that the inflationary pressures sparked by multi-trillion dollar Covid "stimulus" checks in 2020 and 2021 peaked earlier this year, as I have been pointing out for months.
Many factors have contributed to this: growth in the M2 money supply has been essentially zero since late last year, the stimulus checks have ceased, the dollar has been very strong, commodity prices have been very weak, and soaring interest rates have brought the housing market to its knees.
All of these developments mean that the supply of money and the demand to hold it have come back to some semblance of balance, and that is of course essential if inflation is to return to a low and steady rate of, say, 2%.
This all but guarantees that the Fed soon will be scaling back on its tightening agenda. For my money, the FOMC's November 2 rate hike (from 3.25% to 4.0%) should be the last, but a hike next month of 50 bps (to 4.5%) is likely to be the Fed's last move for the foreseeable future.
The Fed simply can't react as fast as the market does to changing realities - unfortunately, the Fed is usually "behind the curve." In any event, a 4.5% funds rate by year end is fully priced into the market and thus it should not be very impactful.
What will change though is the market's expectation for where rates will be a year from now: lower than currently expected, and that is what is driving equity prices higher.
What's most important is that the market is now beginning to see across the valley of uncertainty to a time when inflation comes back down to 2%. It may take up to a year for that to happen, however, but as long as we know that the worst is over, markets can anticipate a lower-inflation future and equity markets can drift higher.
And although it's very good news that inflation has peaked and is now declining, the bad news is that thanks to the 2020-2021 explosion of M2, the general price level will have suffered a major increase that is unlikely to be reversed. Real incomes have suffered and it will take a long time for them to recover.
Chart #1 shows the year over year changes in the total and core (ex-food and energy) versions of the Producer Price index. Both peaked about six months ago, and that was about six months after M2 stopped growing.
Chart #2 shows the 6-mo. annualized change in the total and core versions of the PPI; this highlights the degree of change that has occurred in the past six months.
Chart #3 shows the year over year and 6-mo. annualized changes in the final demand version of the PPI (a version which began in 2009). Here the change is even more dramatic.
Overall, these three charts tell a story of a rapid deceleration in the growth of prices in the early stages of the supply chain. These changes are likely to be reflected in the months to come in a moderation of the growth of the CPI.
Chart #4 shows the ex-energy version of the CPI index (plotted on a log scale so that changes in growth rates can be more easily visible). This version of the CPI (which I think is best because it eliminates the extreme volatility of energy prices) has been growing at about 2% per year for a long time.
After March 2021, it suddenly picked up to a 7% rate of growth. It is likely to continue to grow faster than the former 2% annual trend for perhaps the next 12-15 months even as the year over year growth rate declines.
I'm guessing that when the CPI returns to a 2% annual growth rate, the index will be at least 10-12% higher than the original 2% trend, and that would be about 20% above the level of March '21. Meaning, of course, that the price level will have experienced a one-time increase of at least 10% on top of its typical 2% annual rise.
Inflation will be with us for some time to come, but its rate of increase will continue to moderate. This doesn't mean the Fed has to continue to tighten, however.
Just maintaining its current stance would probably be sufficient to get inflation back down to 2%. That assumes, however, that M2 growth continues to be essentially flat and the government avoids sending out another massive batch of checks funded with the printing press.
Data, Just the Data
Data points this week included: