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September 2022

​Put it in the Rearview


​​It’s the start of the 4th quarter and all I can think about is putting 2022 into the rearview.  It’s been tough on all fronts: an inflation problem that is at least partially self-inflicted; a bear market; a Fed that is throwing the economy deeper into recession; a politically divided country and rising taxes.  Will there be brighter days ahead?  Absolutely.  We just need to buckle down and do what makes America a prosperous, thriving society:  Work hard, innovate, lower taxes and compromise.

The biggest issue we face is getting inflation in check and navigating the Fed’s efforts to raise interest rates to combat the problem.  To put it another way, the Fed is actively trying to slow the economy — even if it means “pain” for businesses and consumers — because it believes that is the prescription for getting inflation under control.  Based on the data I’m seeing, we have most likely reached the peak of inflation, but dropping from 8.5% on a year over year basis to 8.3% isn’t going to solve any problems.  We need to get back down to at least a 3 or 4% level before I’ll declare “victory” over inflation.  Take a look at the chart below showing food inflation historically and the crazy spike since the beginning of 2021.  This is just one area that prices are surging and coupled with housing are currently the biggest drivers of inflation.

 





It does look like what the Fed is doing with their interest rate hikes is working as mortgage rates climbed over 6% for the first time since 2008 (side note, we bought our first house in 2006 with a 6% rate and that was historically low).    Housing, one of the pillars of the economy, is slowing dramatically as seen by the chart below.  These were some of the hottest markets in the US and you can see that prices are falling quickly.  

 







The recession that we’re in (or headed into based on conveniently changing definitions) will likely be different from those of the past. The 2020 COVID-19-induced recession was deep but short-lived. The 2007–2009 financial crisis had deep job losses and a weak recovery. The 2001 recession was mild yet was characterized by a "jobless recovery" with anemic job gains for years after the recession.  In the current one, the most likely outcome is a declining GDP coupled with high but slowing inflation.  The biggest difference will be that unemployment won’t rise too high and it will be a shallower recession as consumers and businesses started this episode in relatively strong shape.

Market forecasting is much more difficult than weather forecasting and here’s the Bull and Bear Case.
Bull Case:

  • Fed does its last outsized (> 25pbs) rate hike in September
  • Inflation moves lower, accelerating the pace of its declines
  • Oil remains below $100
  • Markets stabilize


Bear Case:

  • Fed continues with its outsized rate hikes Nov/Dec, bringing Fed Funds above 4.5-5%
  • Inflation remains in the 8% - 9% range
  • WTI moves back above $100, in response to either supply disruptions and/or an increase in demand from China


In either case, there are opportunities on both the fixed income and equity sides of the markets especially with a long-term plan.   In equities, dividend paying stocks can cushion one from price volatility along with small caps which have been unfairly punished this year and should see outperformance as inflation subsides.  In the fixed income world, as yields have risen, bonds are starting to pay real dividends with predictable monthly income.

I’ll leave you with some links and some anecdotes about energy prices, which is one of the leading causes of our current situation. The Fed is using interest rates to tame inflation, while the government is trying to use the Strategic Petroleum Reserve (SPR) to fight it by selling from the SPR - There's the popular cliche "the Fed can't print oil".  The government is trying to print oil by tapping the SPR.  This ability is obviously finite, so to some extent, one big deflationary driver, the one thing keeping something of a lid on headline inflation, is long-term unsustainable.  The risk remains that at some point the SPR selling stops (because it has to), the downward pressure on oil dissipates, the reserves are left in a depleted state, and domestic production still remains muted.  

Struggling with inflation?  Sports memorabilia prices are booming…The lithium required for all of the electric vehicles is both scarce and can cause massive environmental to obtain it.  Maybe we just need to look for it in areas that are already toxic?  Legalizing sports betting is on the ballot in California this fall – is gambling going to be good for Californians?
Enjoy the fall​​