Economic Monitor: TINA & the Waffles
BY: Mark Drachenberg
It's hard to believe how fast summer is going by. Warm weather and a reopened economy have led to busy weekends and lots of spending on travel and other discretionary items. It kind of reminds me of the song by Prince, “1999,” with lyrics that included, “So tonight I’m gonna party like it’s 1999,” only this year’s lyrics might be, “Have fun and spend money like it’s 2019!”
It is amazing that, when you go out, it seems like 2020 has been wiped from our memories, and, at least from an economic point of view, that is a good thing! The markets have continued moving higher; unemployment is, generally, falling; and demand for goods and services continues to grow, despite supply constraints. All of this has, of course, led to higher inflation and strong earnings reports. However, we all need to keep in mind that these indicators, and others, are coming off last year’s lows and are not necessarily sustainable.
The chase for equities continues to intensify, even while the Fed has sought to clarify its outlook and future plans. That leads us to the title of this post: TINA is an acronym for “there is no alternative” to investing in the equity markets, and “waffles” is my term for the Fed trying to get a handle on its plans. We'll dive in further below.
June was like many other months over the past year, in that larger cap, technology-driven, domestic stocks performed best, while the Dow Jones Industrial Average barely moved. The S&P 500 Index and the NASDAQ Composite Index were the best performers, while mid-cap stocks and international stocks gave up some ground. Bonds made it two months in a row with positive returns, as the Barclays US Aggregate Bond Index gained 0.70%. The shift from growth to value stalled, meaning the large gap in valuations between growth and value stocks widened slightly. An interesting viewpoint is to compare the traditional, market-capitalization-weighted S&P 500 Index with the S&P 500 Equal Weight Index. With the strength value has shown this year, the equal-weighted version is outperforming its cap-weighted counterpart due to the return of value investing over the past year. If value returns to the forefront, we should see the equal-weighted Index continue to outperform. Worth watching.
Also worth watching is how well valuations hold up as we move through earnings season. Strong earnings could help reduce valuations somewhat, if prices do not react as strongly. But that is where the TINA principle comes into play. If there is nowhere else to invest, then dollars will continue to flood into the equity markets and push prices higher. In fact, this is happening right now. According to a July 5th Wall Street Journal article, individual investors bought approximately $28 billion net in stocks and ETFs during June, which was the largest monthly amount since at least 2014. That factor is one to keep an eye on, as it often occurs when the market experiences a melt-up, which tends to precede a collapse. I'm not arguing that this is what's going on now, but it's something to be mindful of.
Economic growth seems to be partying hard – kind of like 1999 or 2019! In fact, it is partying harder than either year, as 2021 growth is expected to reach 7% or more, as compared to 4.8% in 1999 and 2.2% in 2019. Of course, this comes after the decline of about 3.5% in 2020. First-quarter GDP came in at 6.4% and second-quarter GDP is expected to reach approximately 11% before settling down some. Next year’s estimate is 3.1%.
Manufacturing activity has been quite strong, as companies try to meet demand and rebuild inventories. The June ISM Manufacturing Index fell slightly to 60.9, which is still quite robust (a reading above 50 signals expansion, while a reading below 50 signals contraction). This number was likely held back somewhat by issues with supply chains, shortages of raw materials and labor, and other factors.
Inflationary data has steadied somewhat, as some of the transitory items start to lessen their impact on the data (for example, lumber prices have recently fallen by over 40% from their peak earlier this year). Energy is perhaps becoming a concern for the economy, as oil prices surge above $75 a barrel due to infighting in OPEC, strong demand, and last year's fall-off of many fracking drillers in the U.S.
Somewhat concerning is a lack of focus on the enormous amount of deficit spending going on. No one is arguing that some of it was, or is, necessary in times like 2020 or 2008, but the massive amounts of current stimulus may hinder future economic growth. At some point, it will come back to haunt us – well, maybe not us, but surely our kids and grandkids, unless the economy continues to show strong growth.
On to the waffles! No, not the kind you put butter and syrup on – the kind the Fed can be a master at. The Fed has many mouthpieces, not just Chairman Powell. At its meetings in June, Fed members voted on their expectations of future rate hikes. Previously, data pointed to the next rate hike occurring in 2024, but now it shows two rate hikes in 2023. The markets were not thrilled with that information, but when St. Louis Fed president James Bullard came out and said that there would likely be a rate hike in 2022, the markets got outright rattled. Fortunately, things have calmed down, as any rate hike is a still a year or more away, and the Fed has not even begun tapering its bond buying yet. In fact, Chairman Powell said, in a change to previous comments, that “you can think of this meeting as the talking about talking about meeting” about tapering (talk about Fed speak!) So, the waffling continues.
Sometimes the Fed does this to test the market waters, so to speak, and other times it is because of differing opinions. It is important to note that the Fed will not raise rates until it finishes buying bonds and it must start tapering to do that. So, we are perhaps looking at later this year for the tapering process to begin, and sometime in late 2022 or 2023 before a rate hike. That is a lot of time, and the Fed could change its course in the meanwhile. It can be hard to tell what is waffling and what is true, but all eyes and ears remain tuned to the Fed channel. Watch to see what it says after its Jackson Hole meetings in August.
"Steady as she goes" remains our outlook: staying diversified, somewhat defensive-minded, and ready to act if it appears that the economy and markets are headed in a different-than-expected direction. From a market perspective, we continue to stress that a correction sometime over the next six to 12 months is likely, and perhaps overdue. Getting rid of the froth is a normal market condition and could be necessary for things to move substantially higher.
In the meantime, look for areas where valuations may improve, such as value and international stocks, or that may provide some protection, such as floating rate bond funds. For now, enjoy the party, just be prepared for the hangover, whenever it may occur. To discuss your portfolio, or any other issue you may have, please reach out to me or call the Wealth Management division at (608) 826-3570. We look forward to speaking with you.