June 24, 2022

Content But Not Convinced

 In the world of investment nothing offers more false security than a crisp summar

The Markets

The markets have been in decline this year, there is no quick answer for it, capital markets predict the future, but it’s also not as complicated as it sounds. That’s because the future is to the capital markets an uncertainty, otherwise referred to as risk. But the uncertainty becomes denser when additional challenges enter the markets. For example, inflation has been a growing problem since last summer beginning with supply chain disruptions, then we were introduced to 20th century war in the 21st century, then the world learned of the numerous products that are imported from China found a different supply chain disruption as the Chinese government locked down urban areas in the face of a variant of Covid that was failing to hinder the massive surge in international travel taking place in the West. Crisp enough? 

The Fed

It widely understood in the investment community that the Federal Reserve Board is nearly unanimous on being more aggressive in raising interest rates at their monthly meeting to vote. The troublesome area for now is the narrative that follows the vote. This week Fed Chairman Powell addressed the Congress to answer questions regarding inflation and the Fed’s strategy to bring it down. The trouble is one side of aisle is blaming the Russians, and the other side is blaming the current administration’s policies. Little time was spent discussing the post pandemic adventure as a source, given the sharp increase in GDP, sharp drop in unemployment and the numerous regulations that impede the energy industry, further exacerbated by the war in Ukraine and becoming a global problem. On top of that the working public that saw an increase nationally in wage growth over 5.5% over the last twelve months. This is important, in my opinion since the consumer makes up nearly 60% of GDP. And while Manufacturing picked up from its level of 12%, the growth was offset by the decline in Exports coming at the expense the Fed, whose activities to raise interest rates is favorable to the global value of the Dollar, which is deflationary. The Fed has more work to do, not just to battle inflation, but to convince the investing public that they are on top of the problem.

External Events

Uncertainties usually follow the global political and pop culture environment, which these days is nearly indistinguishable. The divisions in Washington are as unstable as ever as is the broad popular culture. The big change is the unintended consequence of the divisions, and that’s the dwindling interest in globalization. The focus of the current narratives, away from the pandemic conspiracies that captured the imaginations of millions of people the world over is, in my opinion, good news. First, because just as the current administration is committed to bringing Semiconductor production domestically, there is increasing agreement regarding the repatriation of other points of production areas of Capital Goods, Consumer Products, Industrial Supplies, the list goes on with nearly 20% coming from China alone. This could go a long way in softening any recessionary slowdown.

In the meantime, last week ended very oversold. However, unless the three major challenges to the Capital Markets are reasonably addressed, Inflation, War and China, the markets definitely have room to correct, but, in my opinion, less so to become a genuine Bull Market.

June 16, 2022

Nice Guys Finish Last

 The Fed raised interest rates yesterday and I’ve made the statement over the past week, that the Capital Markets would respond better if the Fed were too aggressive than if they weren’t aggressive enough. Well, the Fed, as expected, raised rates by .75%, and the market response could best be described as ambivalent. Then Fed Chairman Powell took the stand to take questions and suggested a more aggressive stand as the data comes in to defend the move. This seemed at odds with his statements that the economy was strong and his statement that the goal of the Fed is strong employment. Unfortunately, strong employment is exactly what helped create too much money now faced with too little to buy, which is by definition, inflation. Does Powell mean any of it? It doesn’t matter. As once observed, inflation doesn’t like nice guys, so yesterday Powell tried to show us his tough side. But was it enough?

On the issue of economic growth, strong is not what I’ve been commenting on for at last four months. First of all, one needn’t look far to see that the first quarter of 2022, real GDP came in at an annual rate of negative 1.5%. During the present quarter the ISM Non-Manufacturing index slowed to 55.9, above or below 50 implies expanding or contracting, New Single-Family Home Sales dropped -16.6% in April, Retail Sales Declined- 0.3% in May and as has been typical of the past three months, manufacturing activity has improved since the first quarter, adding to the economic uncertainty that, in my opinion, may be promising to some, but is not a strong economy.

One area that has been resistant to economic moderation has been job growth. Since the challenges faced by the pandemic the vast number of companies that are committed to the new approach, namely providing jobs and community support, and showing it with a hike in wages that has exceeded 5.5% over the past year. However, companies are facing two historical issues right now. Consumer reticence is real, institutional retail entities have found themselves with too much inventory and declining consumer interest. With the need to address these issues on the balance sheet (i.e., bring operating expenses down) the first place most companies will look at are employment costs, which are showing up in casually announced layoffs and hiring freezes. Personally, I like the current pace of executive retirements taking place in the technology sector. Afterall, when Sheryl Sandburg decided to leave Meta (META) her income alone is probably enough to save a few thousand blue collar jobs. 

The handful of times investor and market activity was so volatile, the word “conundrum” became the customary descriptive of the narrative. We still have supply chain disruptions from China, War that is fading from the media, and a dysfunctional OPEC that are all uncertainties on steroids, with little sign of being seriously addressed. There is no denying that even when inflation data peaks, tangible inflation has arrived and much of it will stick around. Only a meaningful economic slowdown, call it a recession will have the necessary influence on consumer activity. This may be because most people are smarter than our government experts take for granted. For now, the markets are very oversold and, in my opinion, it's not a time to sell, but any buying still requires careful consideration. 

June 8, 2022

An Exercise in Trust

 The biggest challenge I have in generating a predictive strategy involves my never ending exercise in trust. Trust of the data, trust of the narrative that interprets it. Needless to say, that’s why I like to simplify my strategy, because strategy, unlike the market, shouldn’t be a rapidly moving target. For this reason, I am drawing attention to what I’m focusing on and how it correlates with current investment exposure to the Industrial, Healthcare and Energy sectors. The biggest challenges that face the capital markets these days are inflation and supply chain disruptions and, in my opinion, the big three culprits where uncertainty reigns are as follows.

The first is the Fed. Inflation is currently being felt domestically in nearly every part of the economy, and clearly being felt by the consumer as recent employment data showed continued hiring (+390K in May) accompanied by a continued increase in employment wages (5.2% over 12mo). This is the tradition of too much money against too few options to buy. But is it more? With clear signs that the economy is slowing in productivity sectors, and retail stores, such as Target (TGT), continue to complain of excess inventory that, in my opinion, has as much to do with lack of consumer interest, then consumer hesitation to buy. In this environment the Fed has not wavered from publicly announcing their intent to increase interest rates when they meet June 14th - 15th. In this light the uncertainty I see is will inflation cease increasing as the economy slows, or when the Fed realizes that the cry of excess retail inventories is a sign of decreasing influence of supply chain disruptions? For now, in my opinion, inflation will eventually stop going up, except when it comes to gasoline, and that’s a problem no one is rushing to solve.

The second is the war in Ukraine. The war in Ukraine and its subsequent initiation of vast sanctions on the Russian economy has led much of the blame for inflation, especially in the energy sector. The current administration has suggested higher gas prices has a positive impact in the transition to electric cars, true, but tell that to the millions of Americans driving for work and play every day. For now, OPEC has no intention of increasing production and most of the countries whose economies are dependent on oil production also happen to be controlled by dictators and authoritarian governments. Hence, my concerns are Ukraine is an excuse for now, but the bigger uncertainty is the potential for escalation of the conflict and what it means for continued rise of China in the Pacific region.

The third is China. The past 12 months have made for very abstract observations. First has been the decimation of the economy, both from the lockdowns from its zero tolerance Covid policies and the second from its crackdown on the technology sector of its economy, one which it spent decades growing. But one area that is ignored by the west is the number of products, pharmaceuticals, medical devices and commodities such as steel, copper and various food products are all huge exports from China. In my opinion, any repatriation of these industries would go far in reducing dependance and therefore intended consequences such as inflation and supply chain disruptions. This is a big uncertainty for the global economies.

The shorter term technicals are moving from oversold to neutral territory without much overall market improvement to show for it. Economic data keeps coming in mixed and the next few weeks could still see some overall improvement in the broad indexes. Most of this will come from indications that after the Fed meeting, treasury interest rates could come down. In addition, the end of a quarter traditionally sees buying, otherwise referred to window dressing, that should see a pick up in the move out of growth into value sectors, such as Healthcare and Energy. Both would keep the markets steady as technicals could slowly move from neutral to negative for the summer. Until then, cash remains our friend.