Friday, September 9, 2022

The market continues to trend down While the economy trends up… “It’s a conundrum.” With apologies to Dr. Alan Greenspan

From the Desk of Joe Rollins

I know it is very frustrating for you as an investor to sit back and watch the market trend down week after week and get nothing but more bad news from the financial press. This is not my first “rodeo” as I have been through many of these downturns in the past. You really have to separate an investing period created by a bad economy from one created by overzealous traders and hedge funds. Today we have that exact situation where investors are losing money and oftentimes making bad investment decisions just because the market is acting in a manner that does not reflect its economic underpinnings. I will try to explain all of this throughout the post.

I also want to look into what is happening in the international markets with China taking a hard line on Covid-19 and the serious problems affecting Europe and their energy crisis. Finally, I want to express my opinion on the phrase you read everywhere in the financial press nowadays, which is “demand for goods and services is slowing throughout the economy.” Hopefully, I can explain that phrase better.
Long-time family client, Anand Nallathambi and his beautiful bride Sara Kate Somers – congratulations!
After a very excellent month of July which was up 9.2%, once again all the indexes were down during the month of August. It has been a whiplash one-up, one-down month for almost a year. However, we must accept the volatility in order to be positioned in a way to benefit when the upturn occurs.

For the month of August, the Standard and Poor’s 500 Index was down 4.1%. For the year, it is down 16.1%, but on a brighter note, over the ten years, this index has averaged a gain of 13.1% per year. During the month of August, the NASDAQ Composite Index was down 4.5% and continues to be down 24.1% for the year 2022. The 10-year average on this index is positive 15.7% per year. The Dow Jones Industrial Average was down 3.7% during the month of August and is down 12% for the year 2022. The 10-year average on this index is positive 11.8% annually.

If you thought you would be more conservative and invest in bonds, you certainly got hurt during August. For the month of August, the Bloomberg Aggregate Bond Index was down 2.8% and is now down 10.7% for the 2022 year. As a comparison to all the indexes above, which have had double-digit gains over the years, the bond index only has a positive return of 1.3% for the 10-year average.

Over 30-year client Jennie Woodlee with her adorable new housemate
I often get calls or emails from clients after a huge drop in the market. I thought I would give you an illustration of why this occurs and why you should ignore it for most investing purposes. On August 26, 2022, the Chairman of the Federal Reserve, Jerome Powell, was to give a speech at the Economic Conference in Montana. The market had just reported excellent labor news and there was a certain amount of euphoria when trading started. However, after Chairman Powell gave his 10-minute speech, where he reemphasized again that the Federal Reserve would have to work hard to keep inflation down, the market immediately turned negative and finished the day with the Dow down over 1,000 points.

Clients really do not seem to understand why these types of trading events occur since they are not in tune with the day-to-day volatility that comes with trading. I wonder how many investors were actually sitting in front of their computers at 10:00 a.m. on Friday, August 26th, to punch the sell button on their securities. As this clearly demonstrates, this selloff occurred because the traders took a negative position due to Chairman Powell’s comments about more interest rate increases.

Size matters – Cici showing Josie how it’s done. 2 pounds vs 80 pounds
Another way you can always spot this type of irrelevant trading is to look at the percentage downturn on each of the indexes. You will note that on a day like this, all the major market indexes were down almost the same percentage. What could have possibly been so wrong that major stocks such as Apple, Microsoft, Amazon, and Google were all down multiple percentages for the day? When you short the market indexes, you must short the good stocks along with the bad stocks. You are not picking a specific stock to short, but you are shorting the entire index in one trade. When you short an index that means you are placing a sell position on the index, whether you own the index or not, the brokerage house will allow you to bet that the index will go down rather than up.

Even though those stocks mentioned above have excellent records and continue to report record profits, they are trending down because they are also the largest component of each of the indexes. So, when you see an index selloff with such a sharp inter-day reversal, you can rest assured that it is not investors who are taking those losses, but traders and hedge funds.

Partner Eddie Wilcox enjoying time with wife Jennifer and daughters Harper + Lucy in Bellevue, Iowa
The same thing happened on September 2, 2022. The unemployment report came out, which was excellent and strong for the economy, and the market, as it should, rallied with the news. Around lunchtime, the Dow Jones was up close to 300 points and there seemed to be a strong buying effort on the part of investors. However, right after lunch, Russia announced that they would no longer provide natural gas to Germany, and they would shut down the pipeline until further notice. Immediately the markets turned around from up 300 points to down 300 points in a matter of minutes. Who exactly was sitting at their terminal watching the markets that day that could move the market more than 600 points in a relatively short amount of time? The traders of course.

Another reality that must be remembered during this time of year is that there are very few traders actually working during this vacation time of year. The volume on the markets have been low recently and it is much easier for a trader to manipulate the market when there is such low volume. Once again, the average investors look down at their portfolio that is losing percentages, meanwhile, this is all artificial trading to benefit traders and hedge funds to the detriment of the average investor.

All these swings in the market should not be construed to believe that the market is bad. The underlying strength of the market continues to be high employment and high corporate earnings. Neither of those appear to me to be winning over the hedge funds and traders. On Friday, September 2nd the Labor Department reported that 315,000 new employees were hired for the month of August. While certainly, this was an excellent number and a great many employees went back to work, it was less than the 526,000 jobs that were reported during the month of July. Maybe this is showing a sign of a decrease in employment, but I highly doubt it.

Aw, they grow up so fast… Ava Rollins at age 2 and age 11
The evidence is everywhere that businesses are seeking employees for all positions. There have been some reported high-profile situations where employers are laying off employees for various corporate reasons, but the Labor Department is reporting that these people who are losing their jobs are quickly finding new ones. Once again, during the month of August, we had an increase in employment in the U.S. and we continue to have twice as many job openings as we have unemployed people in America. If there is an unemployed person today with over 11 million job openings in the U.S., you may rest assured that they are not employed due to their own will. It should not be long before they will run out of money and seek employment.

People are also confused as to why the jobless rate rose to 3.7% in August from the 3.5% low in the previous month. These are statistical numbers that confuse people when they do not read all the details. Even though there was an increase in employment of 315,000, there was a marked increase in the number of people that are in the job market. Market participation is extraordinarily important. Since the pandemic, many people have elected not to work, and the participation rate has only been 60% of the workforce in a given month. This month we saw a rush of new employees back into the employment market, which is an extraordinarily good thing for future employers. With this increase in the number of people willing to work, the percentage of unemployment goes up since the number of people employed divided by the available number of employees creates this average. For all practical purposes, this employment report was a “goldilocks” report. It shows that the economy continues to expand with new employees, but not so hot that it needed immediate reaction by the Federal Reserve in the way of higher rates.

They sure do! Josh Rollins at age 3 (not “fore”) and age 27
Everyone seems to be unsure if inflation is continuing to go up or starting to fall off. A true indicator of the potential for rising inflation is the M2 Money Supply. The M2 Money Supply measures all of the financial assets of households such as savings accounts, time deposits, and balances in retail and money market funds. Basically, it represents the overall savings of American households. This money supply grew dramatically during the pandemic due to the excess government money given to each household. However, recently this index has stalled and has not been growing. With the money supply in excess of $21 trillion, which is still quite high but not growing, many believe this indicates that inflation is slowing. Many economists now believe that inflation has already peaked and is falling and by the first of the year, this so-called fear of inflation should be roughly in line with the Federal Reserve’s target rate of 2% in early 2023.

What is interesting to me is that all of these so-called inflation indicators have not properly forecasted inflation. At one time we were led to believe that gold was the ultimate representation and protection against inflation. However, for the year 2022, gold is down roughly 6.8% – so no help there from gold.

During the peak of the selloffs in 2022, I received many calls from clients that wanted to buy inflation-protected bonds. At that time, the bonds were paying a rate equal to the inflation rate and many thought that this rate was only going to go up. However, if you look at the inflation-protected index represented by Fidelity Investments, you will note that it is down 7.6% for the year and is actually down 6.1% for the 12 months ending August 31, 2022. These very well-known indicators of inflation have not supported the case of higher costs into the future. All of this I believe to be very encouraging information for stock investors. If in fact we have a shift in inflation over the next two or three months, maybe this long grueling selloff will finally turn around.

CPA Erik Kramschuster with wife Carly – cheers!
I rarely get into the details of economic forecasting, but sometimes it’s necessary to make sense of what is going on. One of the most quoted and most important indexes for analyzing the U.S. economy is GDP. Basically, GDP defines the gross sales in an economy. However, there is another important aspect to be considered. For every dollar an individual spends to buy some goods or service (a restaurant meal, a car, a doctor’s visit, or another individual dollar of income for someone to deliver the goods and services), GDP captures the spending size of these transactions. Gross Domestic Income is the other side of the transaction where some earn an income when one spends a dollar. It is the payment for goods and services.

In theory, Gross Domestic Income should equal Gross Domestic Product. That is just common sense. If someone is spending a dollar, someone should be earning a dollar. However, in recent months there has been a wide divergence between Gross Domestic Product and Gross Domestic Income. During the first half of the year, GDP contracted at a 1.1% annual rate that was adjusted for inflation. At the same time, GDI, made up of a measure of corporate profits, wages and benefits, self-employment income, and interest in rent, expanded at a 1.6% annual rate. Maybe, as I have emphasized repeatedly, the economy may not be contracting as much as you are led to believe in the financial press. The traders and hedge funds want you to believe that everything is bad for their benefit.

Alexis Chambers with boyfriend Evan Bentley - Let’s go Braves!
This month we were advised that the GDP had been changed from the second quarter reporting at 0.9% negative to 0.6% negative. So, it could be said that the average in these two quarters was only marginally negative. As I reported in the previous posting, a large amount of this was due to the undercounting of inventory, which clearly had a major effect on GDP in the first quarter of 2022. Now we get the news that the Federal Reserve of Atlanta has posted its projection for the third quarter of GDP at 1.4% (September 7, 2022). If the Atlanta Federal Reserve is correct, they are expecting a major turnaround in GDP in the third quarter from basically a breakeven level in the second quarter to a hearty increase of 1.4% in the third quarter. If the Federal Reserve is forecasting such a large increase and their historic record for predicting these GDP levels has been excellent, why is the financial press so negative? You know for their benefit.

One of the major reasons why people misunderstand the Inflation Index is that they do not understand how it is calculated. Let us assume that on January 1st a product cost $2, but on January 1st of the following year, that product has gone up to $4. Easy arithmetic would allow you to calculate that the inflation rate is 100%. But let us just say for instance that on the following first day of the year that product continues to be priced at $4. In this case the inflation rate is zero given that year over year it has not increased. You as a consumer still feel this price is elevated, but from an economic standpoint it is the same.

DeNay Gonzales not only believes, she knows!
That is the situation that we are now coming into as we roll into the Fall. Much of the increase in inflation was realized at the end of 2021 where the M2 money supply grew dramatically due to government handouts. As we get into the Fall in 2022, we will be comparing inflation reports against each other that do not reflect such a large increase. Therefore, my prediction is that at the beginning of 2023 you should see dramatic declines in inflation, but much of that is due to comparisons with a period of time where inflation was out of control.

We all realize that a large portion of inflation is due to the higher gas prices. But even that is starting to wane. In the West, gas prices remain elevated, but in the South, gas prices have started to decline. In fact, gas prices have declined over the last three months, although only marginally. However, as prices declined, it is noticed by all consumers using energy. All facets of the U.S. economy are driven by gasoline prices. You have farmers using gasoline, and trucks delivering products to the grocery stores and therefore this price is built into the cost of food. As prices of gasoline decline do not expect the price of food to decline, but rather stay constant. The one thing that affects consumers is when they buy an item one day and come back a month later and the price is higher. If we had stable food prices then you would not have the high volatility associated with going up on a monthly basis. We are getting closer to that day.

Big smiles from Dr. Willie Cochran and his lovely wife Rebecca
Clients for over 15 years
I promised I would make reference to the energy shortage going on in Europe. It is a very interesting time for them since the German economy decided that they would stop all forms of energy production in their country and rely solely on the environmentally friendly natural gas. They made a plan to shut down and close all of their coal-generated electric plants. In addition, they phased out all of their nuclear energy producing plants in the county. Their solution to this issue was very simple. They would buy virtually all of their energy needs from Russia.

They entered an agreement with Russia to build an extraordinarily expensive gas pipeline so natural gas could be easily transferred from Russia, where it is in oversupply to Germany which has no supply. It is now believed that at the first of this year, Germany was buying over 80% of their fuel needs directly from Russia. What is interesting is that other countries in the European Union went in the other direction. Virtually all the energy in France is powered by nuclear plants. It was somewhat confusing to investors to watch Germany deactivate all their nuclear plants while France continued to build theirs throughout the countryside. The European Union is not a very tight union.

Power couple Dr. Seenu Gorjala and Dr. Pramoda Gorjala
Clients for 25 years
Now we have come to a time where Russia is using the natural gas as a political weapon against Germany. As of Friday, they announced that the pipeline would be shut for an indefinite time for maintenance. Germany is facing a huge burden in order to provide energy for their upcoming winter. How will a country like Germany get enough natural gas and other forms of energy to keep the country warm during the winter? Most importantly, many industries in Germany use natural gas to provide for their manufacturing facilities. Obviously, these companies will be phased back or deprived of any natural gas, hurting the GDP of Germany.

I vividly remember when then President Donald Trump told Chancellor Angela Merkel that she was endangering their country for relying on Russia for her country’s natural gas, and it seems that prediction has clearly come true. While other countries are trying to fill this void, it would be virtually impossible to provide the amount of natural gas that was being purchased from Russia. In the United States, natural gas is about $7.8 per thousand cubic feet, while natural gas in Germany and Europe is roughly 10 times that amount. The U.S. cannot help this time.

Partner Robby Schultz at Sea Island with a
“baby shark doo doo doo doo doo doo…”
The U.S. is quickly trying to increase its exportation of liquified natural gas. However, the U.S. just does not have enough facilities or capacity to export the amount needed in Germany. Almost assuredly the energy crisis in Europe will reduce the GDP of the countries involved and will almost assuredly create economic hardship for the people that live there.

China is undergoing some major changes that have certainly affected their economy. First, their shut down for COVID seems to be grossly overdone. It was recently announced that they would shut down a city in China with over 21 million residents. You would think based on the news release that this would constitute a severe outbreak of the Covid-19 virus. Come to find out that this shutdown was a result of only 700 known Covid-19 cases. What is interesting about China is that they never adopted the vaccines from the West and due to the massive shutdowns, there are not as many people in China, percentagewise, that have had Covid-19 as in the U.S. The odd thinking on this is that if you shut down a city of 21 million people, whatever virus is there is not likely to spread but the loss of productivity and GDP because of the shutdown would be economically devastating.

Glen and Anita Butler - Clients of 35 years – lookin’ good!
While the U.S. now continues to struggle through and put workers back to work due to the reduction in COVID cases, the Chinese have a zero COVID policy and are willing to shut down productivity and manufacturing in many of their cities. This leads to the conclusion that China is taking a step back from growth in its GDP. If they are willing to suffer a major shutdown in productivity due to such few cases, you must think that their GDP will be greatly reduced for several years to come.

Every day I am asked whether it is good time to invest. As a long-term investor, it really does not bother me what is happening on a day-to-day or week-to-week basis. The only reason I would be concerned is if the economy was falling off a cliff towards a major recession. The traders and hedge funds have a theory that the U.S. could not avoid recession at this point as the Federal Reserve increases interest rates. I think they might just be wrong. Take as an example, we have now more workers than ever in the U.S. earning salaries. Each of those salaries allows for them to go to the grocery store, buy a new car, pay a mortgage on a house, etc. But it is also true that we need to slow the economy.

Lauren Lukowicz, new to our Client Support Team, with Mac – say cheese!
During 2021, we allowed the economy to get out of hand and grow too fast without any direction. Now the economy has slowed in the first two quarters of 2022, but if the Atlanta Federal Reserve is right, it may begin to grow in the third quarter. Certainly, after reflecting on the corporate earnings for the second quarter, Corporate America is really doing very nicely. However, stocks have still been crushed. Right now, 20% of the companies within the S&P 500 have a P/E ratio of less than 10. Given that the historic percentage of price earnings is roughly 17, the fact that so many of them are selling for less than 10 reflects how cheap the market really is. What is even further interesting is that 5% of the S&P 500 have a price earnings ratio of less than 10 and a dividend rate in excess of treasuries. There are many stocks now that are selling at historic low levels without explanation.

For years we have talked about the shortage of computer chips to manufacture cars, computers, televisions, and everything else. Most chip manufacturers today have already sold out of next year’s supply of chips. In fact, I am reading that some major chip manufacturers are selling against 2024 inventories rather than even 2023 inventories. If that were the case, that a manufacturer can sell everything they can possibly make, why are chip stocks down 30%–40% so far in 2022?

People ask me all the time where I get my confidence that the market will come roaring back. First and most importantly, it has never not come back from a downturn. There is a 100% success rate in the market recovering all its losses.

Client Sheryl Matton celebrating her birthday with
daughter Caroline in Florida
What gives me the most confidence is that the best fund managers anywhere in the world are actually performing at a level below what the S&P 500 Index is performing. These are the very best stock pickers in the world and these guys make millions and millions of dollars a year managing stock funds. However, if you look at their portfolios, they are actually losing at a level greater than what the S&P 500 Index is losing. If you analyze their portfolios, you will notice that they are holding the same stocks that everyone on the financial news deems to be toxic. If we are aligned with the best stock pickers in the world, how could we not be in line with a rebound sooner rather than later?

Everywhere around you see economic prosperity. Just go to the airport and wait in line and see if you can get on a flight. I fly often and every seat in every airline is full. I even had to reflect on the future of U.S. citizens as I noted a line all the way down the terminal waiting to get into a Popeye’s Chicken. Americans have money and they want to spend it. With each new employment report, we put more people to work which will generate GDP for the economy. While it is true that higher interest rates will slow various segments of the economy, those segments needed to slow down anyway. Certainly, housing needs to slow down so that we can bring the supply chain back in line with the demand.

I am so amused when I talk to prospective homebuyers, and they quote a 5% rate for a current mortgage. A 5% rate when I was buying my first house would be considered a bargain. The 2% rate that we had for a while was unheard of ever in the history of American finance. What I predict will still happen is that people wanting homes will buy them anyway.

Clients Patty & Jim Radney - A day without laughter is a day wasted!
It is clear the economy has slowed down from 2021, but that is a good thing. It looks to me that the Federal Reserve is taking all the right actions. They are slowing the economy, but they are not dumping it into recession. The unfortunate part of killing inflation is that a large portion of inflation is wages. The only way to dramatically reduce wages is unemployment. I do not think that there is a chance in this world that this government or the Federal Reserve would enjoy seeing fewer people working just to reduce inflation. Therefore, it is my projection that we will see tamer inflation going forward and we will see higher interest rates by the Federal Reserve, but not raises so much as to damage employment. As I have said often in these postings, I still believe we will make money in 2022 and all the volatility and wild moves by the traders and hedge fund managers will be only a bad memory come early 2023.

Almost every day you hear on the financial news that the demand for goods and services is slowing down, but that is actually a good thing because it will slow down the economy. The economy needs to slow down before inflation can be under control. I think this may be one of those phrases that The President uses all the time that lack support. I believe in his mind that if he says it often enough and stern enough people will start to believe that it is the truth. We all know we cannot build enough cars quickly enough and we do not have the microchips to assemble the cars with chip manufacturing backed up for at least two years. The demand for employees creates the problem that the companies cannot produce enough since they do not have enough employees to deliver the services. The problem is not demand; the problem is supply. If we had the capacity to supply the economy with all of the goods and services that it wants, there would not be an excess demand issue. There, of course, would not have been an excess demand issue if consumers did not have excess money. If we were in recession the consumers would not have excess money.

If you have an interest in coming down to visit with us, we look forward to seeing you. We are moving into a slower period for our Firm and will have the time to sit down and review your portfolio, taxes or anything else you might be interested in.

As always, the foregoing includes my opinions, assumptions, and forecasts. It is perfectly possible that I am wrong.

Best Regards,
Joe Rollins

All investments carry a risk of loss, including the possible loss of principal.  There is no assurance that any investment will be profitable.

This commentary contains forward-looking statements, which are provided to allow clients and potential clients the opportunity to understand our beliefs and opinions in respect of the future.  These statements are not guarantees, and undue reliance should not be placed on them.  Forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual results in future periods to differ materially from our expectations.  There can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements.

Saturday, August 13, 2022

Why are employers continuing to hire like gangbusters if we are in a recession… because we are not!

From the Desk of Joe Rollins

There has been no subject more ornately debated in the financial news than whether the U.S. is currently in a recession. I have been saying for some time the economic evidence does not suggest that we are. However, you saw the effect on the stock market when it sold off broadly in June in anticipation of a recession. But the good economic news came on Friday when the employment report reported that employers added 528,000 jobs during the month of July, and that the two previous months had been revised upward showing more hires. We now officially have more jobs than we had before the pandemic began in 2020. It took two months at the beginning of the pandemic for nearly 2.2 million jobs to disappear. We have now climbed back and regained every single one of those jobs, with the unemployment rate now at an impressive 3.5%. With such strong economic news, why do we still have the so-called experts on Wall Street predicting a recession this year?
Drew Malone and his wife, Nicholle, enjoying the beautiful sunset

I want to discuss the items above in this posting, but I also want to share my thoughts on Russia, GDP, corporate earnings, and other matters. Before I go into detail about those most-interesting topics, I need to report on the excellent month of July which basically surprised everyone. As mentioned before, there was a huge sell-off in June in anticipation of corporate earnings reflecting a deep recession. When those negative earnings did not show up, the market rallied back to recover most of June’s losses. Not to say that this year has been great, but at least we are heading in the right direction at the current time.

For the month of July, the Standard and Poor’s Index of 500 stocks was up 9.2% but continues to be down 12.6% for the year 2022. The Nasdaq Composite was up a sterling 12.4% during July but is still down 20.4% for the year. The Dow Jones Industrial Average was up 6.8% but continues to be down 8.6% for the year 2022.
Joe’s replica Braves World Series Rings
and Georgia Bulldogs Championship Ring

I thought I would give you some interesting information to reflect on considering the losses we have incurred in 2022. The S&P 500 over the last five years has averaged 12.8% annual gains and over the last 10 years 13.8%, and these numbers include the current losses. The NASDAQ Composite over five years is up 15.4% per year, and 16.7% per year over 10 years. The Dow Jones Industrial Average is up 10.9% over five years and 12.3% over the last 10 years on an annual basis. These very strong returns should indicate to you that staying invested, even in downturns, is to your advantage. Trying to time the market at a downturn when economic information is confusing only leads to locking in losses and, unfortunately, tax gains.

Even the bond market was positive in July with the Bloomberg Barclays Aggregate Bond Index up 2.4%. It is however, still down 8.1% for the year 2022. Its five-year numbers are 1.3% annualized and 10-year numbers are 1.6% annualized. As you can see, bond returns as compared to stocks is virtually nonexistent.

Shelley Fietsam’s son, Cameron Funna (15), eager for his first day
as a sophomore! Hope that smile lasts…

The employment report on Friday was a true stunner to virtually all economic observers. The final number was roughly double what the so-called experts were forecasting. In fact, the 3.5% unemployment rate was the best unemployment rate in over half a century. Think about that and put it into perspective. If we were in a recession or going into one, how would we have such a low unemployment rate? There was one interesting observation in the employment report - there are 623,000 fewer people in the workforce than before the pandemic. It makes you wonder why those people are not working when clearly there are a substantial number of jobs for them to take. I believe that a vast majority of these people probably received economic help during the pandemic and at the current time have no desire to return to work. As those employees run out of savings surely, they too will return to looking for a job.

You would think with the impending “recession” the job openings would have gone down. While they have declined marginally from last month, there are still 10,698,000 jobs available with a total of 5,670,000 currently unemployed. Once again, this month the number of job openings is twice the number of people currently unemployed. In the last one-year alone, the unemployment rate has gone from 5.4% to currently 3.5% which is the lowest level since the pandemic. This is also a 50-year low for unemployment.

The current pilot shortage is worse than we thought:
Caroline (8) and Reid (6) ready for take-off

Sometimes you must put economic ratios into practical everyday thinking. Why would employers anticipating a downturn in their business go on a hiring spree such as they did during the month of July? What rational and reasonable businessman would continue to hire people knowing the potential for the business to turn down? Although there are some notable companies currently laying off workers now, the overall hiring throughout the country quickly consumes those unemployed and gives them another job. It may not be a better job than what they had, but at least they are working. With the revised data reflecting a larger number of employees hired over the past 2 months, there is no question that there is an extraordinarily strong labor market in the U.S. today. One employer told me yesterday that they had 4.500 open jobs at the current time that they could not fill.

There has been much said about reducing inflation and it appears that the Federal Reserve is bound and determined to push up interest rates to the point of stopping inflation in its tracks. Over the last two months there has been a marked decrease in commodity pricing including the price of gasoline going down over $1 per gallon. However, a major part of inflation relates to labor and housing. The U.S. Department of Labor reported that year after year employees’ wages went up by 5.3%, and of course housing followed that increase. While the decrease in commodity pricing is beneficial and the gasoline price decrease is monumental, do not expect inflation to go down quickly because the labor rate and housing costs will keep it elevated. To truly stop inflation may take several years and several rate increases. While we are not in a recession now, there is no guarantee that the Federal Reserve will not push us into one in the future. However, that could be many good investing years away before we get there. We will be watching.

Ava riding a WaveRunner with her Uncle Chip Tucker

I did not want to get into the technicalities of how the GDP is calculated but given the last several quarters of GDP being reported, some explanation is warranted. You may not recall, but for the 4th quarter 2021 GDP went up at a very strong rate of 5.6%. For the first two quarters of 2022, the GDP was down roughly 1% each quarter. As soon as the second negative GDP report came out, all the pessimists proclaimed the U.S. economy to be in recession since the definition of recession is two negative GDPs in a row. However, the experts thought this early declaration was completely misguided.

One of the components of GDP calculation is the increase in inventories. When inventories go up, the assumption is that GDP is stronger because manufacturing must be productive in order to generate these goods. If inventories go negative, then that is a drawdown of the GDP. 2021 was a most unusual time. Because of supply chain issues, retailers overbought inventory anticipating shortages. To their surprise all these inventories showed up prior to the end of the year and major retailers were stuck with more than was needed. Walmart and Target both indicated that their inventories are far in excess of their needs and will have to reduce prices to liquidate the inventories. These reduced prices help fight inflation because this brings down the cost of clothes and accessories sold by both of those major retail chains. However, it also affects GDP. So, for the first two quarters of 2022 inventories are drawn down reducing GDP growth in both of those quarters. If you would have held inventory steady during the first six months of 2022, the GDP would have been marginally higher.

Long-time clients Lloyd and Laura King visiting Fenway Park in Boston

The GDP is a backwards-looking measure, and not what the stock market is all about. What we want to know is what GDP is going forward. The Atlanta Federal Reserve posted their projections of the GDP for the 3rd quarter and currently that number is 2.5%. They have been particularly accurate over this time in forecasting GDP. Just for reference, the St. Louis Federal Reserve also forecasts GDP and they have forecasted it at 2.45% for the current quarter. Therefore, two major Federal Reserve offices have forecasted a positive GDP growth in the 3rd quarter of 2022. Just maybe the so-called experts on Wall Street will reassess their call for recession, which seems to be premature. If we could get the talk of recession off the news and get back to corporate earnings as we should, the second half of 2022 should be excellent.

The one thing that amazes me is that the so-called economists do not understand the economic effect of putting a half million people back to work in 2022. When you have a great labor market recovery like we are experiencing now, it tends to set off vicious positive cycles. Job gains lead to increased wealth of the workers and robust consumer spending. When you have robust consumer spending, employers are required to hire more employees and therefore creating a double effect, with a renewed need for more employees in retail. I have been saying for some time that this increase in employment will create more taxes for the government. As you decrease income taxes as we did under the last administration, we create more employment not less. More people paying in taxes during a full employment cycle is excellent for government revenues. As you hire more and more people, this creates a competitive nature for jobs and employers must increase wages to retain good employees. Once again, all the positives of full employment that we are realizing today are covered up daily by the financial news’ talks of recession.

Evan Bentley and staff member Alexis Chambers celebrating
the 4th of July in downtown Pittsburgh

As mentioned previously, the month of June was a huge downturn for the markets with the anticipation that corporate earnings would be negative and the projections for the coming years would be catastrophic due to said recession. However, as earnings started rolling in during July it became crystal clear that corporate America was not realizing the negative results as forecasted by the analysts, and the market quickly turned around, gaining dramatically. The numbers are pretty much overwhelming. At the current time there are 432 companies that have reported within the S&P 500 Index. Of these companies, 77% of those have reported better than expected results. The average increase in actual earnings over expected earnings are 5.8% so far this month. Truly an extraordinary performance in corporate profits. What recession?

What is also unusual is that revenue growth in these companies is up 13% for the quarter. It is hard to imagine that if we were in a real recession, we would enjoy a 13% increase in gross revenues in corporate America. Now, all the robust earnings reports have not reduced the potential of a revision of future earnings by these companies. The revisions today are down very little compared to their reported corporate earnings. So, you must ask yourself if you are a reasonable person and a “shade tree economist” analyzing the facts, “Why would corporate America go on a hiring binge in July if they anticipate recession? Why would corporate profits continue to be robust in the second quarter of 2022 if we were already in recession?” I guess it is fairly clear that even the trained economists could now recognize that at the current time we are not in recession, but that does not mean that a recession could be declared in the coming years. We will be the first to report the first signs of recession.

Josh and Ava spending some quality brother-sister time together
on the beach in Florida

From an economic standpoint, we have to drag a term out of the 70’s to define this current economy. The term “stagflation” is now the word to describe where we are. In a period of “stagflation”, you have low economic growth but high inflation. So, assuming that the Atlanta Federal Reserve is correct, and we have 2.5% GDP growth in the third quarter of 2022, that would not keep up with inflation which is projected to be somewhere in the 8% range over the coming year. I would be the last one to tell you that you cannot make profits in an economy with low economic growth. I think the second quarter has already proven that fact. Inflation, in fact, is good for corporate America by increasing the value of their assets without them having to spend money. We are obviously in a fragile time where major adjustments to the economy could be devastating for future economic events. Any proposed increase in taxes would certainly have a negative effect on the economy and would likely lead to layoffs and lesser earnings by employees in America.

I would be hard-pressed not to place the blame directly in the lap of the current administration in D.C. The increase in the price of gasoline in America to meet their environmental wants has created a large tax on all Americans. As pointed out before, when you increase the price of gasoline you automatically increase the price of food - virtually everything is driven by demand and the price of gasoline. Even though gasoline has decreased recently in price, it is still up 100% from the time the current administration was sworn into office.

Caroline Schultz striking a pose in Anguilla

We are now in a situation where we must decrease inflation, but is it going to create massive unemployment in America? Which of the two dual mandates of the Federal Reserve are most important? As you know those dual mandates are full employment and low inflation. We currently have full employment, but high inflation. Are we as a country willing to increase interest rates high enough to reduce inflation at the cost of laying off millions of Americans from their jobs? What we have seen since this administration has come into office, is a mix of trillions of dollars in Federal spending, heavy regulation, and the threat of higher taxes. Rather than continue with the above negative economic policies, why not try the opposite? That would mean slowing interest rate increases and allowing the economy to correct on its own without intervention by the government.

Only in Washington, DC could you define a bill that borrows and spends $700 billion and call it an Inflation Reduction Act. There is nothing in the current bill that will reduce inflation and any time you borrow money, that is a negative for future taxpayers in America. But more importantly, it is a really bad time to increase taxes on anybody with the economy at this stage of barely breaking even. It has been proven by various analysts that the 15% minimum tax on big corporations will hurt manufacturers more than anyone else. For years we have been attempting to bring manufacturing back to the U.S. and now a bill is proposed to increase the taxes on those very manufacturers. You could not have timed a worse increase in taxes on an industry that is susceptible to downturn with every new expense which slows down manufacturing in the U.S.

Fore! Ava and Joe Rollins out for a spin in Florida

The bill also has a proposal that the U.S. government could negotiate prices of pharmaceuticals under Medicare. Can you imagine anyone less qualified to negotiate prices with major pharmaceutical companies than the government? Almost assuredly this will lead to a shortage of needed medicines and reduce the research and development of new drugs in the U.S. A double negative for the economy without question. It is very interesting that before the pandemic we had pro-growth policies which led to a strong economy with steady growth, low inflation and real wage increases of 3% or higher for 19 straight months. Since the change in administration, we have had more spending and more tax hikes that only fueled more inflation.

If you really want to decrease inflation you need to lower the cost of government against manufacturers by cutting regulations which would allow the increase in supply through regulation relief which would once again fund pro-growth. This is not rocket science. If you increase taxes in an otherwise soft economy, the likelihood is that you will hurt the average employee and for whatever good reason the bill is enacted, it will be overshadowed by the negative employment trends if we have to lay off employees due to high inflation.

Getting ready for a new year at a new school! Knock ‘em dead, Ava!

The so-called Inflation Reduction Act passed the Senate on Saturday with a straight up 50/50 vote along political lines. This bill will be hastily enacted prior to the mid-term elections when the majority party realizes that they have little chance to maintain the House and Senate in the midterm election. It is shocking that Congress does not take the time to debate a bill that has such major long-term effects on Americans. Increasing spending and increasing taxes goes against every principle we know in economics. In a slow economy increasing spending increases inflation and increasing taxes decreases the economy. The two difficult issues we have with this economy today this bill moves in the opposite direction from helping and actually hurts everything currently in the economy.

I thought I would throw in some information regarding the Ukrainian War. I keep up with it even though it has fallen out of favor with the national media. There is no question that the Ukrainians have done a fabulous job in holding off the Russians even though they were likely to lose eventually. They could not have done so without the billions in economic aid from the U.S. and other countries. But there is a very important outcome of this war that people are not realizing. Due to the length of the war, Russia is using up a great amount of its military hardware and missile capacity in a failed effort to capture the entire country. It is now reported that Russia has lost over 1,832 tanks in the fighting in Ukraine along with 4,086 armored combat vehicles. In addition, each ballistic missile they fire costs millions of dollars and they have used up a large portion of their inventory of these missiles. Notwithstanding the tragedy of loss of life, it is reported now that more than 40,000 Russian soldiers have been killed in action in this war. Every time I hear a number like that all I can think about is each of those lost lives have families and children that will suffer in the future due to not having a parent. If you can realize anything about a waste of a life, fighting in a country that does not want you makes no sense. This loss of life is a true tragedy for both countries.

Mia Musciano-Howard taking a dip with her two new friends in Jamaica

The most important point is that due to sanctions, it would be very difficult for the Russian military to restock. Much of their military armament comes from components out of the U.S. which they can no longer buy. In addition, the sanctions to their citizens are substantial. Since their currency is not accepted in most places in the world at the current time, virtually none of the Russian citizens can go on their expensive vacations to places like the French Riviera. The hardships created in Russia over a war that makes no sense to virtually anyone is depressing. However, the long-term effects of the military in Russia being disarmed due to a prolonged military operation is extraordinarily beneficial to the rest of the world. They will be weaker when we grow stronger.

I could not believe that so many forecasters were arguing that Russia would take over Ukraine in a few days and then invade Poland. Russia has now been trying to unsuccessfully take over Ukraine for six months and they do not have the men or the equipment to challenge Poland which is a NATO member. Recently Finland and Sweden joined NATO, now leaving the country of Russia completely surrounded by NATO members. Those of you that are not familiar with NATO, it is an organization of countries that would fight for each other in the case of an attack by a hostile country. NATO has 5 million troops, Russia has 900,000. They will not touch Poland.

Interesting fact: Anguilla, not only beautiful but no income tax, capital gains tax, estate tax, or other form of direct taxation on individuals.

The question will always be, can Putin carry out this mission without creating irreparable damage to his country and economy? I think once we get a resolution of the Ukrainian war, we will get a better understanding of what the economic effect will be in Russia. Each soldier that has died is one less person adding to the GDP in Russia. I project that by the end of 2022 there will be a resolution of the Ukrainian war. More likely than not, it will be a draw with each getting certain parts of the country, followed by peace. It is going to be a long time before Russia rebounds from the losses incurred in Ukraine. However, if the U.S. is persistent in keeping the sanctions in place, economically it could bring Russia down during our lifetime.

I have told many clients over the last six months that I still anticipate that the markets will be positive for the year 2022. I understand that it is a high goal given the losses that we have incurred so far. However, when you attempt to forecast the future growth of the market you must take into effect the earnings, the interest rates, and the economy. At the current time earnings are great, the economy is good, and the interest rates are higher. I still believe however that the economy can continue to grow, although modestly, in the coming year but earnings will continue to improve. If I am correct about earnings continuing to grow, the markets should continue to rally, and we should see higher returns coming up. I know after the first six months everyone was down on investing and very depressed. After the month of July and the first week of August, your optimism should be firmly in place. I have seen this kind of market for over 40 years, and it has always recovered. And it will recover again.

As always, the foregoing includes my opinions, assumptions, and forecasts. It is perfectly possible that I am wrong.

Best Regards,
Joe Rollins

All investments carry a risk of loss, including the possible loss of principal.  There is no assurance that any investment will be profitable.

This commentary contains forward-looking statements, which are provided to allow clients and potential clients the opportunity to understand our beliefs and opinions in respect of the future.  These statements are not guarantees, and undue reliance should not be placed on them.  Forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual results in future periods to differ materially from our expectations.  There can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements.