No Fear Here
Looking objectively at the US Equity markets so far this year, one has to think that there is little fear of recession. Normally, preparing for a recession, one would adjust their portfolio accordingly. Drop some tech, buy some defensive stocks, keep a sharper eye on your fixed income positions. Not today.
The markets seem to be concentrating on fairly decent earnings and disregarding those forward looking statements. The idea here is that my company had better than expected earnings in the fourth quarter, so that means they will figure out the first and second quarter equally as well. As if things always remain the same.
It’s the concept of ignorant inertia. People sit on their hands because they are stupid. Happens in almost every area of life. I know it’s harsh but how can one make sense of not doing anything when you have more facts available to you than ever before.
Here are just a few examples: The War in Ukraine. You have that dastardly villain, Vladimir Putin, amassing tanks on the Northern Border and Western Border of Ukraine. The Americans and NATO knew the invasion was coming, yet the billions in arms wouldn’t start flowing for two months. Huh? How is that possible. Another example, The Federal Government flooded the US economy with an unprecedented amount of cash and the Fed sat there and said the price rises were “Transitory”. BTW, I said six months before the Fed announced we were in an inflationary period that we were in an inflation spiral. Look it up. Anyway, history is littered with people sitting on their hands and yes, I know, “Hindsight is wonderful and foresight is impossible”.
Just like watching the equity rallies we have seen this year. Are these investors expecting some sort of miracle in the second and third quarter? Are they positioning themselves for, what I believe will be a serious rally into the end of the year? Hardly. The investors moving money into the market so far this year are disregarding the warning signs and that is a scary thing because any trading environment where the warning signs are disregarded or missed, disaster ensues.
Market optimism seems to be about the quarter that passed and not the coming quarters and that is what scares me. Companies seem to be posted fairly robust earnings despite rising prices.
Just think about that for a second. In past inflationary spirals, sales have increased for the first 9 months or so. Earnings increases lagged but got there eventually. Then the bottom would fall out of the price rises and sales and earnings all took a hit. In this inflationary period, prices have risen and earnings have stayed almost in lockstep. Any economics textbook will tell you that there is the lag I spoke of. Not this time. Why? My sense is that corporations have taken the price rises further than the underlying costs warrant. They have taken advantage of this situation by raising prices 10-15% when their costs (labor included) have only risen 5 to 8%. Hence, the difference is all profit. Shareholders fears are nullified and executive compensation remains record setting.
It is not a complex idea and if you try and prove it, it will be quite hard because every producer has used supply chain issues and labor issues. Hard to argue and dig deep enough to prove it. But I say bull****. They had an once in a generation opportunity to ram much higher prices on us and they did. They made smaller packages and charged the same. They discontinued coupons. They took the power away from the consumer and brought it back to the producer. All with the idea of shareholder happiness in mind.
This tale does not have a neat or happy ending unfortunately. As I have said numerous times in the past. Inflation at some point eats itself. Meaning, prices get too high, consumers balk or go for a cheaper product or buy less. Pressure on supply/demand recalibrates and prices come in. Case closed. Or does it?
Here is where things get a tad ugly. With the eventual slowing of prices and slowing of demand because of those prices you may see some contraction in prices. Generally, it is great to see prices come back down until it becomes it’s own little monster. This contraction turns into disinflation and then you have much bigger problems.
A recession, when mild can have some disinflationary effects but mild recessions don’t last long enough or go deep enough to really cause a disinflationary period. Zero growth or negative growth for a quarter just does what the Fed is trying to do. Bring inflation down to their preferred level. The contraction in the job market that a recession brings on is a bigger worry but the Fed has the tools again to stimulation job expansion so we may see that momentary print of 5 1/2 % unemployment but it will be short lived. The danger is that disinflation stays longer than expected and corporate profits crater.
That is a worst case scenario for sure but the Fed is trying to decide if they should pause (my choice) , raise the Fed Funds rate 25BPS or 50BPS. Consensus says a 25BPS move on the upside is expected with maybe one more similar move before summer. As always, the Fed is playing a serious balancing act and based on past history, I am not sure they will get this right.
I am not trying to make a case here for anything in particular. As investors with a clear sight line, you don’t need to worry all that much about why the market is doing this today or that tomorrow. Long term, you will always do better with a well balanced mix of stocks and adjusting your portfolio from time to time.
All I ever try to do is explain things the way I see them. I give a modestly educated opinion and try to get the reader to think a little bit about what is actually happening in the market. As always, if you disagree, drop me a line and I hope to learn something from your thoughts as well.