It's October and Things can Get a Little Scary.
Having experienced one very big crash in October and several smaller ones, I can attest to the fact that October can be a wicked month. Since I am already calling for a correction of some sort in the equity markets, why don’t we just lay it out now.
I just can’t do what I want to do and that is to say definitively that we will see a major selloff and the World will once again be thrown for an economic loop. I can’t but that doesn’t mean I don’t think the longer this goes on, the chances of a major correction grow.
If you look at economic conditions in this country and globally, things are improving once again and growth, which has been off the charts, is still north of 5% for the time being so why would equity markets correct? There really is no reason, yet, to see any sort of sustained sell off. Interest rates are still low. The Fed has pumped trillions of dollars into the system and it is making it’s way to Main Street finally. Consumer spending, which took a nap during the height of the Pandemic has been fairly strong even if it isn’t multi-directional. Lastly, the US Government is about to throw anywhere from 1.5 trillion to 5.0 trillion dollars at the economy and that, regardless of what passes Congress, will continue to sustain the economy.
So what gives? Why am I building more and more caution?
Several reasons:
The Federal Reserves main engine of growth will be tapering down and a dependable form of liquidity will dry up. That alone wouldn’t really impact Main Street all that much but along with the possibility of an even longer period of inflation, you are going to see growth slow in real terms. The infrastructure bill will most likely pass at some point and that will be a legitimate, longer term flow of money into the system and the benefits will outweigh the negatives by a good margin. Granted, this bill will increase the US deficit even more but sometimes governments just need to spend on the right things and figure it out later.
In keeping with the past history of our Federal Government, the infrastructure bill has a little something for everyone and as I have mentioned in previous columns, it probably could have done more on actual infrastructure and less on filling the private sectors role but it’s Congress and they need everyone to “Wet the Beak” as they say.
However, even with this much needed help rebuilding our roads, bridges, tunnels, there is a downside, besides debt, and that is increased spending and increased cash flowing into the system. We are awash in cash in this country and looking at it simplistically, thats a good thing, but that excess cash also has unintended consequences as well.
Inflation.
Because of the Pandemic we have seen a total disruption to our supply chain here and abroad. This has led to probably the most significant cause/effect of inflation. Demand for good and services is exceeding supply. Wage increases are happening and at a level we have not seen in a generation. Commodity prices are soaring. The competition for transportation is also causing problems at different chokepoints around the country.
This competition for goods and services will be the prevalent theme for the coming year and this is where you need to keep an eye on equities. While companies have been reporting much better than expected earnings for the last three quarters, there will be a point in time where this competition for goods and services will impact those earnings. That is your correction moment.
Right now companies have been dealing with supply issues and have been passing on those added costs to consumers and the consumers, desperate for the products they fear may not be available will purchase those products even though the costs have gone up dramatically. The unused purchasing power of the consumer in this country is still pretty large but as that shrinks, people will not pay up for non-essentials and eventually will look to save by buying unbranded products. Smells like a recession no?
While I am no fan of using interest rates as a cudgel to smash inflation, I think the Federal Reserve knows the power of raising rates in quelling inflationary spirals. The problem with the Fed however, is that they have totally misread the inflation component and may act too harshly, too late. Want to talk about a buzz kill to stocks? Talk about rising interest rates and see what happens.
Admittedly, I am not an economist and I might be wrong about this but from a ground up perspective it looks to me like there is going to be a reckoning. Our economy is slowly being mismanaged and reality is not one of the components those in charge actually understand. Granted it is very complicated but I don’t think it takes a PHD to see that we are slowly (but not that slowly) moving into a period of economic disruption that may take years to unwind.
I didn’t even mention an increase in taxes!