Thursday, December 8, 2022

Stock Market Rally – A Conundrum Between What You Hear From the Media and What You See in Real Life

From the Desk of Joe Rollins

For the last two months, the Standard and Poor’s 500 Stock Index was up 14.1% yet you do not read much about that rally in the financial press. At the end of September 2022, the S&P 500 was down 23.9%, clearly in bear market territory. At the end of November 2022, that same index was down 13.1%, increasing nicely over the past two months. Yet, as you and I watch the financial news daily, all we hear is negative financial information based on this so-called upcoming recession that everyone seems to be predicting.

I want to cover some of those facts for you in this posting and some other subjects I find of interest. The U.S. posted another strong employment report on Friday, but the big question is, where have all the workers gone? Particularly, the younger male employees seem to be nowhere in sight in the employment report. I also want to focus on why consumers are accumulating so much cash but are spending their savings to either stay out of work or reduce their working hours. I also want to try to explain the absolute absurdity of the financial press and its emphasis on layoffs; the numbers are meaningless in the grand scheme of things. Also, I want to focus on the increase in GDP that has occurred this year, contrary to any reports you might hear of the economy slowing. Lastly, I must once again take a shot at the traders who are confusing investors with irrelevant information. I want our clients to focus on investing and ignore the hype the traders are publishing in the local press.

Lucy and Harper Wilcox up to a little hocus-pocus
in Salem, Massachusetts
Before I report on all that interesting information, I need to report on the month of November 2022. For the month of November 2022, the S&P 500 Stock Index was up a very healthy 5.6% yet is down 13.1% for the year 2022. Just as a comparison, the 10-year average, including this down year, is 13.3% annually. The NASDAQ Composite Stock Index was up 4.5% for the month of November 2022 and is down 26.2% for the year 2022. The 10-year average on this index is up 15.6% annually. You would expect an index that is more volatile than the others to be down more in a down market and up more over time. As you can see, it has had the highest double-digit increases over the last ten years.

The Dow Jones Industrials Average Stock Index was up 6% for the month of November 2022 and is only down 2.9% for the year 2022. Its 10-year average is 12.9%. In comparison, the Bloomberg Barclays Aggregate Bond Index was up 3.8% for the month of November 2022 but still down 12.5% for the year 2022. Its 10-year average is a measly 1.1% over the last ten years. It pays to note that the bond index is down almost as much as the S&P 500 Stock Index, at 12.5% to 13.1%. It is highly unusual that both stocks and bonds are down in the same year. In fact, this has not happened since 1969.

We had a very strong unemployment report last Friday, with the United States adding 263,000 new jobs. It was surprising to the traders that the unemployment report remained at 3.7%. Going into this quarter there was an assumption by the financial press that due to the higher interest rates, the Federal Reserve has been applying to the economy. Unemployment should be going up. At some point, it will affect jobs causing the unemployment report to go higher. However, during 2022, even though the higher rates of interest has been moving higher, the number of people unemployed has either fallen or stayed stable throughout 2022.

Snowbirds - The Rollins Family headed south for Thanksgiving
Some of you may not remember, but in 2019 we thought that we had a super strong economy, and that it could do no wrong given its overall strength. However, the job growth in 2019 had a monthly average of 164,000 jobs per month. Compare that with the job growth now over the last three months, and it has grown to over 272,000 jobs per month. As you can see the job growth in 2022 is actually faster than in 2019.

One of the issues the Federal Reserve continues to cite is that if employment is strong, they will have to continue to increase interest rates to slow the economy. However, there is tons of information that will illustrate that employment is not out of control. Today, in the United States, there are 158 million workers currently employed out of a civilian workforce of 164 million. Obviously, the two indicate that there are roughly six million Americans unemployed, which is down from the 6.8 million 2021 average. Basically, the number of unemployed over the last year has been reduced by roughly 800,000 Americans.

Danielle Van Lear and Robby Schultz
May your days be merry + bright!
What continues to be the conundrum of employment is there are currently 10 million job openings and only six million unemployed people. As you can see, there are almost two job openings per every unemployed American. It is clear that if you are unemployed and want a job, there are plenty of jobs available.

When interest rates started going up in the spring of 2022, the so-called experts projected that the U.S. would fall into recession in 2022 and the GDP would fall off the chart. As a matter of fact, in September, many of the largest brokerage houses forecasted that there would be another drop off in stocks of 25% before the end of the year. As mentioned above, the S&P rallied 14.1% in October and November 2022, which I guess made their projections somewhat moot.

“Chur!” Martha and Lee Nemeth on a speed boat adventure
near Queensland, New Zealand
The one fact that continues to astound me is the call on the Gross Domestic Product of the United States. You would expect, with all the negative news, that the GDP would be crashing and burning during this particular time. In the first two quarters of the year 2022, the GDP was down 1.6% and 0.6%, forecasting a potential recession with two negative GDP quarters in a row. However, those two quarters came following the very strong 2021 GDP of 5.7%, which bled over to the year 2022.

Astoundingly, the GDP for the third quarter was recently revised upward to 2.9% by the Commerce Department. This GDP surprised most all viewers of the economy since they were expecting negative not positive numbers. Currently, the Federal Reserve of Atlanta is forecasting GDP growth in the fourth quarter of 2022 to be 2.8%. If we in fact hit that percentage for the year 2022, the entire year will be a positive GDP growth, making the economic picture even more confusing to those looking at it from the outside. When does the recession start, surely not in 2022?

Of course, the financial press says that they were not wrong about GDP growth, it is just delayed until 2023. In fact, due to the strong GDP growth, this would push the Federal Reserve to increase interest rates even higher and longer. However, the evidence would indicate something different as I will illustrate later.

Ken & Una Dooley’s grandkids -
“The best gift is the presence of family wrapped in love!”
One of the things that continues to baffle me is why the stock market reacts to an announcement that a company is going to lay off workers. The company Amazon recently announced that they were going to lay off 10,000 workers and the market drove the stock down 4% based on the news. However, obviously, the people that traded on that news do not understand the employment history of Amazon.

In 2019, Amazon had 1.3 million workers. From 2018 to 2019, they increased their workforce by 62%. In 2020, Amazon had 1.6 million workers, which was an increase of 23% year over year. As you can tell, 10,000 workers being laid off is a small percentage of their total workforce and is certainly meaningless. I would bet on a day-to-day basis, based on 1.6 million workers, they probably hire and fire more than 10,000 employees each and every workday.

Eddie and Lucy Wilcox at Harvard - getting an early start on college visits
With the economic news it only makes sense that they would pare back some of the employment that they have accelerated throughout the years. Likewise, you are reading about layoffs of workers in the tech sector. Once again, the tech sector has been aggressively hiring employees for the last four to five years due to the pandemic. A reduction in hiring or laying off excess employees only makes good business sense and when they make those announcements, the stocks should go up rather than down.

I want to remind you that with all this so-called negative news related to employment, there are still 10 million job openings for people to take a job. It has recently been announced that the people laid off, particularly in the retail sectors, had quickly found jobs in other industries that are short employees.

In the most recent unemployment report, something shocking is appearing. Not only are the number of workers in the United States declining due to retirement and other reasons, but the participation by the most productive group in the employment pool, males ages 25 to 54, has dropped from 89.3% to 88.4%, which is a significant number in any one age group. Since this age group is the most qualified in most segments of the economy, it is hard to understand why this group is dropping out of the workforce altogether.

Josh and Ava – Sensei and Grasshopper or Grasshopper and Sensei?
In males aged 20 to 24, participation has dropped 1.7% from January 2020 versus 0.5% for those aged 45 to 54. As you can see the number of workers in the United States is falling in virtually every category of young males. No one can seem to explain why these jobs are no longer filled by them. It may just be that these employees have accumulated too much money during the pandemic and just do not desire to go back to work. Once again, this very strange conundrum of the amount of money Americans hold as compared to the amount of young males working raises additional questions about whether these employees will return anytime soon to the workforce.

Take as an example; a recent Federal Reserve report estimated that U.S. households, as of mid-2022, were sitting on $1.7 trillion in excess savings. Make sure you understand that I am not talking about millions, I am talking about trillions of dollars. It is further interesting that during the most recent year, the personal savings rate for Americans had dropped from a high last year during this month at 7.3% to an October low of this year of 2.3%. I think it is pretty clear what you are seeing. So many workers that were in the workforce are now electing to spend their savings rather than go back to work. With the significant reduction in the savings rate, it should be fairly obvious to everyone that these workers no longer need a job because they are spending their savings earned during the pandemic.

Murray and Susan Van Lear rockin’ around the Christmas tree
One of the questions always addressed to me is, how did Americans accumulate $1.7 trillion in excess savings? Much of it can be directly linked to the government subsidy during the pandemic. As you recall, unemployment payments during that time were greatly expanded in order to cover the people currently out of work. But there have been numerous other government handouts that have increased the amount of cash held by Americans. As you recall, even though the President proclaimed that the pandemic was over, there was a major increase in food stamp payments implemented during the pandemic as a humanitarian help for people out of work. However, those food stamp beneficiary payments have not stopped. Currently, the average food stamp monthly benefit is $227 per month, which is nearly twice as much as before the pandemic.

If you look at the political football, which is student loan payments, you will note, once again, even though the pandemic is proclaimed over, the payment holiday on those payments has been extended to June 2023. It is assumed by the Federal Reserve that the average savings due to these loan payments being postponed saves an average debtor of roughly $12,800 a year.

“Small cheer and great welcome make a merry feast.”
- William Shakespeare (not pictured)
As you can see, there are many monthly subsidies that are going into the hands of workers that are no longer willing to work and be employed. As long as the government continues to subsidize these workers, they are comfortable spending their savings in order to maintain a lifestyle that does not require them to work on a daily basis. Also, with the higher interest rates passed to the public by the Federal Reserve, now the savings of these workers is earning more. Last year at this time interest rates on money market accounts were paying virtually a zero-interest rate for the year. Today, those same accounts are earning for savers roughly 3.5% per year. This substantial increase in earnings on these savings accounts further insulates workers from having to go back to work anytime soon.

You probably didn’t notice since most people do not actually look at interest rates daily, but long-term interest rates have fallen dramatically for the last several months. Not only has the stock market rallied, but so have the interest rates. Most recently the 10-year treasury was quoted at 4.25% annually, but today that rate has dropped to 3.5% as of this week. That is a huge drop in only a few weeks. What is very interesting about this drop is that clearly interest rates affect long-term mortgages. With this dramatic drop in 10-year treasuries, it is very likely that mortgage rates will fall from 6% to in the 5% area.

Psst, over here! Elon Musk as guest speaker at the Baron Conference
Once again, this is very bullish for home purchasing and lower mortgage rates. One of the items that I am often confronted with is a young couple indicating that they would postpone purchasing a new home for another year because of the increase in interest rates. I find that philosophy to be flawed. If you think about it for a second, if you have to pay 3% higher on your mortgage than you would have six months ago, while uncomfortable, it may be what you need to do to get the house. It is very likely that home values will continue to increase by at least the inflation rate of 2% to 3% per year. If you wait a year and you lose 2% appreciation on the value of the house but pay a 3% higher rate, you have lost 1% of the value of the house. However, the alternative is if you rent for one more year, and you are paying $2,000 a month for rent, you have completely lost $24,000. Homeownership continues to be much more desirable for young couples than renting.

The decrease in long-term interest rates is important for another reason. The Federal Reserve has pretty good control over short-term rates. They can move rates higher very quickly, which affects short-term interest rates such as the 1, 2 or 3-year treasury bonds. However, they have virtually no control over the long-term rates. So, what you are seeing in the actual world is that while the Federal Reserve continues to push up short-term rates the long-term rates that are affected by the investors are falling.

Caroline Schultz – 8th year in a row on Santa’s nice list!
I think it is fairly clear from the movement in the interest rate that the markets are betting that shortly after the Federal Reserve increases rates again, they will begin cutting them after the first of the year. Also, the reduction in the long-term rates tells you that there is a pronounced decline in inflation, or these rates would not be falling. We see the price of lumber going down dramatically due to lower home starts and we see the price of gasoline falling dramatically due to the perceived state of the economy. I think as the Federal Reserve contemplates increasing interest rates now, they will have to consider the reduction in inflation.

The Chairman of the Federal Reserve, Jerome Powell, has already announced that during the December Federal Reserve meeting, the interest rate increase will be 0.5% rather than his customary 0.75%. I think the Federal Reserve is finally seeing, and maybe it is from the pressure of the public, that taking the country into recession would be a mistake for both the Federal Reserve and the country as a whole. I do not believe for a second Federal Chairman Jerome Powell wants to put the country into severe recession. Given the falling interest rates and the clear movement in reduced inflation, it does not look to me that he will be required to do so.

Cecilia Cmeyla and Anam Syed striking a pose at the Omni Hotel
As you would expect the financial specialists do not agree. A Bloomberg survey of economists released last week found that three-quarters believe that the Fed will act too aggressively, eventually triggering a global recession. I cannot explain why this group would be so negative on the ability of the Federal Reserve given their public pronouncements that no one has the desire to put the country into recession.

I guess it has to do with the cycle that we went through in the late 1970s with Federal Chairman Paul Volcker. At the time when Chairman Volcker took over the Federal Reserve inflation rate was 12%, mainly due to the Arab oil embargo against the United States. To bring down inflation, Chairman Volcker immediately forced the country into recession by driving up interest rates to more than 22% and mortgage rates to nearly 17% in the process. Not only did he increase interest rates, but he also restricted the money supply forcing a severe recession in the economy. Unemployment during that time stood at 10% and peaked at 10.8% in 1982.

Reid Schultz showing that he’s strong enough
to batten down the hatches!
Recall that the unemployment report today is 3.7% in the United States. There is no question that the Chairman of the Federal Reserve has the capacity and ability to put the country into recession. The question is why they would want to do so given the already declining inflation picture. As I mentioned in the last posting, I do not believe that this Chairman has the desire to put 10 million Americans out of work today. Remember that Chairman Powell is not a trained economist. In fact, he is an attorney by trade, and I think he is very cognizant of the public pressure to not overshoot this very important interest rate cycle.

My only hope for my clients is that they do not watch too much television related to the financial markets and they do not overreact to things they see on TV. I want to give you an example of how the data is so misinterpreted. Last week all the financial press could talk about was the fact that the Covid-19 shutdown in China was restricting the production of iPhones for Apple products. China is taking a very aggressive approach on Covid-19 protection and has basically shut down many cities for only a few cases. However, one of the major manufacturers of iPhones is in that shutdown area and has had to reduce their working hours because of the Covid-19 restrictions.

Elizabeth Flores and Jose Reyes Ventura.
Dream big, shine more, and sparkle bright!
The financial media went crazy last week discussing the issue that Apple would not be able to produce the number of iPhones they had predicted during the current quarter. Due to production delays, it would be impossible to meet their production projections going into Christmas. As a result of the comments, Apple stock fell roughly 5% during the time in which this discussion was ongoing. Understanding that these are traders making these types of trades and not investors, I hope you see through the controversy.

Yes, it is true that Apple may not be able to meet their production quotas due to their Covid-19 restrictions, but basically so what? They will meet those quotas in the coming weeks and months even though it may not be before Christmas. This event, while it influences the short period of time between now and Christmas, should never have any negative effects on the strength of Apple. Therefore, let the traders sell for the two weeks and buy back, and long-term investors should sit tight.

Once again it brings me to a conundrum that I cannot fully explain. The S&P 500 Index is up 14.1% for the months of October and November 2022 which is good news for long-term investors. It is also fairly clear that the U.S. economy’s GDP has moved higher after being negative for the first two quarters of 2022 and is looking to be positive for the last two quarters of 2022. Also, we know now that the supply constraints are virtually eliminated, and I was recently told that freight rates out of China, which were $53,000 earlier this spring, have now dropped to $1,200 per container. When you see that type of change in the marketplace, you know that whatever constraints there were now have been basically resolved.

It’s a boy!!!
Congratulations to Drew and Nicholle Malone!
We also know that employment is extraordinarily strong with an almost all-time low unemployment record in America. The more people that are working, the more people are spending money and the more people that are building the economy. In a recent trip to Florida, you could not get reservations at any restaurants and traffic from Atlanta to Tampa was bumper-to-bumper the entire way. If you go out to a mall during this time, you will note that they are almost at capacity levels. It was recently announced that over Black Friday, cyber retail sales were up 9.4%, which was a record. Normal brick-and-mortar retailers reported an increase in sales of 2.7%. You are just not seeing any level of softness in the current economy. If we had these economic numbers in 2019, we would have believed that we were in a record-strong economy. We had those numbers in 2022 but the perception is exactly the opposite.

While it has been an extraordinarily disappointing year financially, I have great hopes for the future. I think the ridiculous selloff of big tech is going to end soon and you are going to see a massive rally in those stocks that are down 20% to 30% this year. They are the most important companies in America and certainly, nothing that we have seen so far should limit their growth. Therefore, I see this as a major buying opportunity for young people and people that are willing to wait for the stock market to turn back up.

As we go into 2023, I believe we are going to see smaller interest rate increases by the Federal Reserve and if the economy continues as strong as it is today, earnings by major corporations will be higher in 2023 than they were in 2019, further pushing the stock market higher. I know it is frustrating to sit here and watch the stock market go down. But when you have a performance where in the last 20 years, the market has been up 16 times, you have to expect one year to be a negative return. If you have 16 up years and four down years, that is a win rate of 80%.

CiCi sends you holiday joy from the beach in Florida!
I expect 2023 to be better, and if you have excess cash you should invest today or at least do your IRAs early in the year so you get the benefit of the reduced value of stocks that currently exist. Since it is not likely you are going to have major capital gains this year from the mutual funds, it might be an opportune time to make a conversion. If this is something you are considering, reach out to us as soon as possible and we can do a quick calculation and tell you the tax consequences of converting.

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.

Wednesday, November 16, 2022

Do you believe Powell will eliminate 10 million American jobs? I don’t!

From the Desk of Joe Rollins

I have been overwhelmed with questions regarding the economy and what has been going on with the stock market over the last month and I am beginning to believe that the public is being overwhelmed with fake news. I read an article the other day that said the vast majority of Americans believe we are already in recession; they fear for their jobs and the ability to support their families. However, the evidence is so far removed from those statements that it must be bewildering to someone who actually reads the facts.

I hope I can give you some information in this posting regarding the excellent month of October we enjoyed, but more importantly, explain to you why the economy is not in recession. If you believe the lines they give you on TV, you need to do your own homework. I also want to explain employment which seems to have gotten confused with the economy since people do not understand that layoffs do not necessarily create a recession. Lastly, I want to go through my reflections on meeting with Elon Musk in New York and hearing his coherent statements regarding virtually anything as compared to politicians. Of course, I will touch on the elections and the reasons why they were important for further stock market increases.

Ava Rollins and her friends having a roaring good time on Halloween

If anybody tells you they can forecast a bottom to the stock market, they are just born liars. No one has ever been able to do so, and if anyone could do so, they would certainly keep it to themselves. What we do know, historically speaking, every sizable stock market decline has represented a sure-fire buying opportunity for long-term investors. I know it is hard, you just have to hold your nose and buy on the dips. Did you realize that over the last 70 years the stock market has declined by over 10% on 39 separate occasions? You probably did not realize that market corrections were as common as those facts tell you. Yet, in every one of those 39 declines of 10% or more (except for the current one) a bull market rally eventually recoups all that was lost. Given that it is a 100% recuperation of all losses indicates this too at some point will pass. A really good time to invest.

Before I cover all those interesting topics, I need to report on the very excellent month we had in October. The Standard and Poor's Index of 500 Stocks was up 8.1% for the month of October, but yet is still down 17.7% for the year 2022. Once again, I point out the 10-year returns on this index, even with this very down year, average 12.8%. The Dow Jones Industrial Average was up 14.1% for the month of October yet is still down -8.4% for the year 2022. The 10-year average on this index is 12.2%. The NASDAQ Composite was up 4% for the month of October but is still down significantly at 29.3% for the year 2022. The 10-year average on this index, due to its more volatile nature, is also the highest at 15.2%.

Ava out for a graceful spin around Central Park

For the month of October, the Bloomberg Barclays Aggregate Bond Index was down 1.4%. For the year, bonds are down 15.6% and for the 10-year they average at 0.7%. This is the first time on record that bonds have taken such a large decline and the combination of both stocks and bonds being down is almost unheard of in American finance. Maybe this leads to some of the conspiracy theories I will discuss later in this posting.

As mentioned in the prologue, I find it incredible that most Americans believe that we are already in recession. If you recall back in January and February all these so-called experts were beating the table and explaining that recession was unavoidable in 2022, and that in 2023 we would likely see bread lines, foreclosures, and huge bad debts by the banks. I am not sure exactly where those Pundits get their information from, but it is certainly not supported by the facts. You must wonder whether there is a broad conspiracy going around that is convincing the public of something very negative, when in fact, we are in just a normal slowdown in the economy.

Shelley Fietsam’s son, Cameron, dressed to impress for HOCO 2022

I guess the Pundits were shocked when the government reported that the GDP for the third quarter was at 2.6%. While it is true that during the first and second quarters of 2022, the GDP was marginally negative. So, the increase of 2.6% for the third quarter must have been a sure shock to those Pundits that were beating the table and explaining how recession was just around the corner. However, if you want really shocking news, check out the website for the Atlanta Federal Reserve. As I have pointed out on numerous postings before, these preliminary calls on GDP by the Atlanta Federal Reserve have been closer than any other projections. If we were going to have a recession in 2022, the fourth quarter would have to be a large negative number to wipe out the 2.6% earned in the third quarter. However, as strange as it may seem, the Atlanta Federal Reserve is forecasting fourth quarter GDP at a stunning 4% increase. If in fact they are close to that percentage increase for the fourth quarter of 2022, the entire 2022 will be quite satisfactorily higher on a GDP basis.

What confuses me, and I guess most investors, is why these so-called experts are forecasting severe recession when the government itself is forecasting real growth in the current quarter.

I have been on a lot of airplanes lately and I can tell you from personal observation that every seat is full and there is a standby line on every flight I have boarded. Airports are completely run over with people; and as everyone knows, it is almost impossible to get reservations at a good restaurant. I was in New York City over the weekend and most of the hotel rooms were sold out and the city was covered up with tourists. In fact, I began to believe that no one spoke English in New York after the few days there since there were so many tourists from foreign countries. That fact alone should convince you that the world is not in recession, given that whole families were willing to travel from Italy, France, and the Far East to come to New York on vacation.

Client Chris Barg with Braves’ Dansby Swanson
at the Gold Glove Awards in NYC
I have a hard time convincing my own clients to read the facts. I get client telling me that when Facebook starts laying off employees, it must mean we have recession. In recent news, all the major tech companies reported that they would slow down hiring or start laying off people in the coming months. Unlike the explanation of the upcoming recession, this more properly reflects that corporate America is downsizing to a slower economy. That is only good common sense and exactly what they should do if they thought their business would be slower going forward. Absolutely nothing in those statements would be an indication of an upcoming recession.

Also recall, that if you lay off a couple thousand employees by a major employer, as of today, there are still 10.7 million job openings in the U.S. that are not filled. So, if these newly laid-off employees desire to find new employment, they have vast opportunity to do so. As I said often said before, for anybody in America that wants a job, there are plenty available. If someone is without a job, it is most likely that they do not desire to work again.

This gets me back to the title of this posting. If the U.S. is really going to go into recession, the Federal Reserve will have to orchestrate laying off and eliminating over 10 million American jobs. Take that into perspective when you consider employers today cannot find enough workers and especially low-paying jobs that are going unfilled because no one is willing to work for those wages. Will the government now take that situation and aggravate the economy by laying off 10 million additional workers to reduce inflation and slow the economy. I am betting there is no chance in the world that any governmental agency in an election year would eliminate that many jobs and endanger that many families' livelihoods over something as obscure as the inflation rate.

Ken Higgins finished his 38th Peachtree Road Race – Way to Go, Ken!

So maybe the Pundits are saying that we are going to see severe recession in 2023 due to the actions of the Federal Reserve and we have just not felt the effects of higher interest rates. There is no question that higher interest rates have slowed the housing industry by pushing long-term housing mortgage rates up above 7%. I do not know if you have noticed but those rates are falling and are now below 7%. Truth be told, most people really do not care what houses cost, they only care what the monthly payments are. With the huge increase in interest rates over the last six months, many young buyers are suffering “sticker shock” with new home pricing. However, I have many clients on the other side of the housing industry, and I can tell you that housing prices are not going to fall if commodity prices for those houses continue to rise. Sure, there will be a slowdown in housing but frankly, there needs to be.

We got a little bit ahead of ourselves in the spring when lumber prices doubled, and supply chain issues made building houses come almost to a standstill. Now that lumber prices are back to normal and the supply chains have opened; efficiency in home building will improve, but it will take some time. So, it is perfectly fine that the economy slowed down some to allow housing to catch up with current demand. The people who write for the financial news and talk about “crashing” home prices and the desperation felt in home building obviously have no clue as to what they are reporting. While last month housing prices declined by 1.5%, given that they have increased by 20% over the last year seems to be a most normal reflection of softer pricing.

Bob and Margaret Cash preparing for a bike ride
through Burgundy, France – À tout à l’heure!

The difference that so many of the people writing the financial blogs cannot seem to understand is that we do not have an undersupply of product, we have an oversupply of demand. Coming out of the Covid shutdown for several years, suddenly people wanted to use the money that they had accumulated since they had not been able to do anything in two years and they began to travel and spend money on capital items. We had too few new cars to buy, we had too few used cars to sell, lumber was at exorbitant prices and every airline seat was filled. That is what happens when you have demand in excess of supply. But all of that is slowly receding and supply and demand are more closely aligned today than they were several months ago.

So, when we have more aligned supply and demand, we will start to control inflation. For the month of October inflation was down to 7.7% year over year from 8.2% in September. Remember that I explained that inflation is valuated based on an annual increase this month over same month last year. As we go into the end of the year, we will have much more favorable months to compare, and I fully expect inflation to continue to fall as previously mentioned.

Long-time client Claude Hoopes shares the beauty of Maine!

At the very first sign of a significant reduction in inflation, you will see that the Federal Reserve will have to back off this desire to increase interest rates in this economy. It is a fine line to increase interest rates to slow the economy, but under no circumstances would you want to do so to the point where interest rates throw the economy into severe recession. I think the Federal Reserve is very cognizant of this fact and that when they meet in December, the increases in interest rates will be less than the 0.75 that they have been increasing for most of 2022.
So, I talked about the economy, and I talked about what I think the Federal Reserve is going to do, but what really affects stock prices are earnings. With all the talk about the potential of recession, most people have failed to see the reality of what is going on in corporate America. It is amazing to me that bank stocks are not rallying significantly with these higher interest rates. As you know, every time they increase interest rates, the banks make more money, yet bank stocks have been down virtually all year and even flat lately. The Pundits have convinced the public that the reason why bank stocks cannot rise is because with the upcoming recession, the banks will have overwhelming debts and companies that cannot pay their loans. I find that position so preposterous it is even hard to repeat. The banks today are in the most healthy and well capitalized position they have ever been in American finance.

If the Pundits were so correct regarding their projections of inflation and recession in 2022, you would have expected that earnings would fall dramatically. It now looks like that for 2022 in corporate America, net income will go up by 7.5% for the year 2022. What is incredibly coincidental is that is the exact same percentage that they went up in 2021. So, we have no declining employment and no declining earnings by major corporations. Why are the most major stock funds in the world down 30%-40% in the year 2022 and the S&P 500 down 18%?

Proud moment - Randy and Kathy Wittman
introducing their 3rd grandchild!

While I was in New York I had the opportunity to talk to a lot of the fund managers and their reflection on this year was quite surprising. They all indicated that nothing had really changed and that they were evaluating stocks as they had always done. The exclamations seen in the financial press of recession, depression and hyperinflation were to be ignored given that there was no financial support for those positions. While we all recognize and appreciate the slowdown in the economy, there is no indication of a major fallout from corporate America. Therefore, even though their performance this year has been uncharacteristically bad, their position is that you still value stocks the same way and all this hyper talk in the press is probably designed to support a position that the traders have that the invested public does not.

People ask me all the time what my reflection of the recent election was and my thoughts about it going forward. I am quite pleased that the elections appeared to be an even split between the two major parties. I am also very glad that neither party won substantial positions in any of the major house and senate races. I am a firm believer that government works best when it does nothing. It is the old joke Ronald Reagan used to paraphrase all the time, “I am from the government, and I am here to help.” As Ronald Reagan said, anytime the government shows up to help you may rest assured that industry will be worse for that help. Therefore, virtually an even split in Congress and in the Senate should lead to two really good years of the government doing absolutely nothing. As long as the government continues to debate, argue and make excuses and not pass any substantial legislation, we as investors will be much better off.

Ava and Dakota Rollins in the Big Apple

One of the principal speakers at the seminar I attended was Elon Musk, President of Tesla Motors and various other companies. It was very enlightening to hear his comments. I found this guy brilliant beyond belief. Not only did he start PayPal from scratch, but he also started the very first fully electric car manufacturer, Tesla, SpaceX, Solar City, and Starlink. No one in the history of world had been successful in the building of electric cars before Elon Musk came along. When I listened to him speak, I was so impressed by his intellect. I just wish we had politicians that had above-average intelligence.

One of the things that he said seemed to make a lot of sense. He said that while studying space geography as part of SpaceX, he discovered that there might be as many as one million planets with the same atmospheric conditions as Earth. The difference is that those planets do not have people on them. Maybe at one-point, multiple generations ago they actually had people but they either killed each other in war, a virus wiped out the whole planet or environmental effects got to them. What was interesting about his comments is that he related them to the same effect on the Earth. Here you have one madman in Russia attacking a neighboring country for no good reason and wiping out hundreds of thousands young men. What if someone like him could start a nuclear war and basically eliminate all the people on earth? At least we now know that Elon Musk is certainly thinking about it.

One last pit stop before heading home...

What was fascinating about this conversation was that the very next day when I picked up my phone and looked on the internet, every other article I read was a negative article written about Elon Musk. You would think that if there were anyone to be the darling of the progressives, it would be him. No one before him was able to build an electric car cutting car emissions. Many have tried, but all have failed. Even today, the major car manufacturers are so far behind Tesla that the race is not even fair. Yet the progressives for some reason hate Elon Musk beyond belief. Maybe it is because he is the richest man in the world, or he has become remarkably successful.

Another thing he said that impressed me was that he indicated that the President of the United States should never be more than 15 years older than the average American. If the average American is 38.1 years old, that will make the President’s age around 53. Think about that just for a second when you have Biden and Trump running for political office again at age 80. They are so far removed from the average American’s beliefs and daily activities; I am not sure how they can properly govern a country. Hopefully, in this next Presidential election, we will have some young people willing to run.

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.

Wednesday, October 19, 2022

The Weirdest Diversions of Economic Reality vs. Market Performance of All Time

From the Desk of Joe Rollins

I know it is unbearably painful to watch the stock market negatively perform most days. However, for the 50 years that I have been invested, you can always rely on the fact that earnings and the economic environment will eventually return to the performance of the markets. That is where I feel we are today, and I want to point out some of those facts to you. In addition, I want to better explain the role of the Federal Reserve and the effect it is having on the current market. Lastly, I want to explain the extraordinary market performance we have had over the last 20 years and why pessimism at this level is certainly not warranted.

Before I go on to those more interesting subjects, I must report the performance of the markets for the month of September. It is unbelievable how bad the stock market performance was during that month. Not only were stocks down, but so were bonds, internationals, real estate, and virtually every other asset class you can name. What was interesting was that Fidelity’s lineup of sixty equity funds, which included some conservative funds, some midcap funds, and some aggressive funds, on average were down 9.2% for the month of September. By any standards, in any definition, it was an extraordinarily difficult move down for any one month. What was even worse for that quarter was all these funds were down 4.3% and the sixty equity funds were down 23.8% year-to-date. It just goes to show that there is nowhere to hide in this relentless selloff which is not supported by economic data.

The Standard and Poor’s Index of 500 Stocks was down 9.2% for the month of September and for the year down 23.9%. The 10-year performance on this index, including this down year, is 11.7%. The NASDAQ Composite Index was down 10.4% for September, down 32% for the 2022 year, and its 10-year performance is 14.2%. The Dow Jones Industrial Average was down 8.8% for the month of September and year-to-date is down 19.7%, but its 10-year performance is 10.4% annually. Just as a comparison, Bloomberg Barclays Aggregate Bond Index was down a stunning 4.3% for the month of September, is down 14.6% for the 2022 year, and its 10-year performance is 0.9% per year.

JRR sitting in JFK’s rocking chair

It is extraordinarily unusual when both stocks and bonds go down at the same time. If you had employed the 60/40 asset allocation, you would have suffered heavy losses so far in 2022. I am not trying to make a commentary on general performance, but it is quite unusual when virtually every asset class and every type of stock fund are all down during the same month. I am just not a believer that the millions of people that invest money suddenly decided that cash was better for the month of September.

The Federal Reserve was established to accomplish two major goals in the U.S. economy. The first was to maintain a stable economy which, by their definition, means inflation should be 2% not 8.5% as it is today. Their second mandate was to maintain full employment during good times and bad times. Neither of those mandates are more important than the other. Even though you have full employment and outrageous inflation, you are going to have an unstable economy. At 3.5% unemployment, we are in a very strong labor market. However, with 8.5% inflation, the Federal Reserve feels that it needs to take precautionary actions to reduce inflation.

The Federal Reserve of Atlanta has done a particularly good job in forecasting GDP going back over time. After reading all the negative commentaries in the news, you would assume that GDP would be a huge negative number for the third quarter of 2022. In reading the Yahoo headlines, virtually every other article was negative on the U.S. economy and how bad things are and how people cannot meet their monthly debts. The general sentiment from reading most of the editorial comments on the finances of Americans assumes that millions are out of work and underpaid and cannot meet their monthly household budget. Bread lines are surely next.

37-year client Allen Davidson & friends enjoying that
fresh NC mountain air

However, if you actually read the data, nothing like that exists. The Federal Reserve of Atlanta is now forecasting GDP growth for the third quarter at 2.8%. Remember that the first two quarters of 2022 were marginally negative. This forecast assumes a major positive turn in the economy. Do you remember all the so-called experts forecasting recession in 2022? I guess they will have to wait another year.

Basically, if these estimates are correct, the U.S. is growing 2.8% in the third quarter with a 3.5% unemployment rate. Any country in the world would do handstands to have such excellent financial numbers, and yet we are facing a market that is down 23.9% year-to-date.

As for the unemployed, currently there are still two job openings for every one person that is unemployed in this country. There is absolutely no reason why anyone cannot get a job if they want one, since there are massive job openings. In addition, those workers that do have jobs have enjoyed a 5% increase in pay over the last year which, of course, adds to the inflation problem but allows those employees to meet their monthly obligations more easily.

Client Janis Whitehead out on the town with husband John Jergel

The major question now confronting the Federal Reserve is whether they have gone up too far too fast and have not given the economy an opportunity to absorb the rate increases. There is no question that the higher interest rates will start to affect housing prices at some point. However, let’s not put it out of context. In most housing markets in the United States, house values have gone up between 20% and 30% in the last few years. If these housing costs incurred a decline of a couple of percentage points, that hardly seems unreasonable given the sharp upturn. Higher interest rates obviously affect credit cards, car loans, and other types of financing vehicles. Once again, the incurring of credit card debt, new car loans, and other financing is optional to the average citizen and certainly avoidable if they desire to reduce spending.

The major obstacle in bringing down inflation will be reducing the cost of oil. Any number of rate increases will not reduce the price of oil but rather move the political needle more than interest rates. The formation of these large inflation increases began with the current Administration’s pledge to reduce oil production in the United States.

During the prior Administration, we enjoyed energy independence, but we are currently dependent on foreign oil which, in my opinion, is a huge mistake. By reducing drilling in the United States and regulatory overburden to the industry, basically the ripples of higher inflation were created at the beginning of 2021. At this point, overregulation and lack of permits has reduced drilling over the last couple of years, and exportation has taken a back seat. At the current time, there is absolutely no way to reduce the price of oil short of a change in regulatory authority out of Washington.

Cecilia Cmeyla calling out of work from Disney World

You can see the effect that it is having on the rest of the world. Recently, the Administration tried to lobby Saudi Arabia and the Middle Eastern countries not to cut production of current oil supplies. It was reported that they decided to cut production by one million barrels a day to increase prices. After strong arm negotiations by the United States Administration, Saudi Arabia, Kuwait, and the United Arab Emirates decided not to cut the production of one million barrels a day, but rather cut two million barrels a day. Oh well – so much for U.S. influence.

The Administration warned the Saudis that a decrease in production would impact the long-term future of the United States and the Middle Eastern countries. Clearly, their decision proves that the United States has less influence over the Middle East than Russia does. Obviously, the higher prices will allow Russia to sell oil at a higher price and therefore support their ongoing atrocious war.

The sad part about all this pain that we are suffering with inflation and higher interest rates all could be reversed tomorrow by the signing of a new bill. If the White House would call off this political and regulatory campaign against American oil and oil production, the price of oil would start to fall immediately. We would see an explosion in the exportation and production of oil, which would get us back to the energy independence we saw only 18 months ago.

“Ava Rollins, do you have any homework?”

It is difficult to explain why the equity markets have been so decimated in 2022 given the strong economic numbers that we have enjoyed. Plus, we have an extraordinarily long record of positive performance, and we now know that every single bear market has grown into a bull market in every downturn. Ever since 1928, the S&P 500 has fallen 20% or more on 21 separate occasions. That does not include the 2022 performance since it is not over yet. That means that on average, there is a bear market every 4.5 years. Yet, it has not only recovered from every single one of those slumps, but it has gone on to see positive returns and more.

Think about this for a second. In the last 19 years of the stock market performance, there have only been two negative years. Of course, we had the extraordinarily big loss in 2008 and the other loss was only marginally negative. If you were a gambling person and I gave you money to go to Las Vegas and I told you that if you bet 19 times, you would win 17 of those times, you would take that chance every single time. The odds of a major correction going forward seem absolutely and totally remote.

Let us look at the current performance. Based on the information we currently have available to us now and the forecast by the Federal Reserve of Atlanta, the GDP for the quarter ending September 30th should be pretty positive.

Ziming Yu – Don’t make him angry!

We know that there are more people working now than ever, and therefore, there are more people to spend in the economy and make it stronger. Think about this for a second; going into this quarter it is projected that the earnings will be 2.9% higher than the previous years' earnings. In my way of thinking, that makes these companies 2.9% more valuable than they were on January 1, 2022. If the companies are more valuable because the earnings are higher, why is the performance down 23.9%? Once again, I focus on the fact that there seems to be a coalition of traders who are determined not to allow this market to trade up. I have noticed that over the last 60 days that the last trade of the day, on any given day, is a highly negative one. Therefore, if the market does trade up a few percentage points during the day, those gains are essentially wiped out by one large block trade making it negative.

An example of an extreme swing in the market was when they announced the Consumer Price Index for the month of September on October 12, 2022. At 8:30 in the morning, the inflation report was published and was one-tenth of one percent higher than expected. Immediately the futures went from 300 up to 500 down. The market opened down 500 or 600 points almost immediately, but throughout the course of the day those losses turned into huge gains. The Dow Jones Industrial Average Index ended up over 800 points that day when it started out negative 500. So basically, the S&P 500 Index on that day fell 2.4% before finishing up 2.6%, a five-point percentage swing. This type of inner-day action has only happened nine times since 1983, according to Bespoke Investment Group data. Do you really think that the average investor is sitting there by their computer, trading a market with wild fluctuations on a given Wednesday? Do you understand how much money it would take to move the market by 1,500 points? Of course, as you would expect, later in the week, the market sold off, basically to neutralize that large swing. This type of trading is not for investors.

Mia and her dad Muzzie (95) spending some
father-daughter time at the game!

Everyone is raising the question of whether the Federal Reserve is moving too quickly. I am a strong believer that the people in charge of the Federal Reserve are very well-educated and do see all the data. It has always been believed that if you have a rate increase, it will take as long as six to nine months before that rate increase takes effect in the economy. During 2022 alone, the Federal Reserve has already raised rates five times. The last three raises were more punishing increases of 75 basis points each. It is also forecasted now that they will increase interest rates by .75% in November and .5% in December. All of this is designed to get the Federal Funds Rate above 4% prior to the end of the year. The real mystery is that with all these increases within the last six months, have they been too much for the economy to absorb all at the same time?

I am one that would recommend that the Federal Reserve slow down and actually see whether these increases have actually done their work. I am in the camp of economist Dr. Jeremy Siegel who is now pronouncing that “the Federal Reserve has slammed the brakes way too far.” He is of the opinion that already the components leading to major inflation have been put in place. He is afraid, as am I, that the Federal Reserve is moving too quickly and not giving time to evaluate those increases. As he says, “most of the inflation is behind us, and the biggest threat is a recession, not inflation today.” He is arguing that the Federal Reserve might be doing more damage to the economy than good by raising rates and potentially forcing the economy into recession. No one knows exactly what the answer to that question is, but it certainly raises a legitimate concern.

Patiently waiting for the market to rally…

I often think to myself, is it the work of the government to destroy a strong economy? If we had this great economy back in 2019 prior to the Covid-19 downturn, all of us would feel good and happy and the Federal Reserve would be content on allowing the good times to continue. However, today, with an extraordinarily good economy and virtually full employment, there is a really bad attitude among American populists. I suspect more so than ever that this sentiment is leading to many of the strong negative feelings on Wall Street. Assuming that the Federal Reserve carries out its tasks and truly moves the economy from a 2.8% increase to a negative GDP, the net effect can only be that they will have to put 10 million people in America out of work. The only way we are going to get inflation under control is to reduce employment and reduce the profitability of businesses. Is it fair for the government to say to these families that they will no longer get a wage or health insurance or be able to meet their monthly bills? At the end of the day, which is worse, having some inflation or having 10 million people out of work in the U.S.?

My opinion is that we certainly want to reduce inflation going forward, but it is not as devastating to the economy as politicians seem to be making it. What would be devastating to me would be to force all these people out of work for no reason. Therefore, I join Dr. Siegel in saying that maybe it is time for the Federal Reserve to back off and slow down their increases until we have time to see how those increases will actually affect the economy.

Joe, Drew, Mia and Shelley enjoying the Braves’ one win of the series!

So, all the above was written under the full understanding that so far, the downturn in the stock market has been extraordinarily bad given the positive economic evidence. I cannot explain that downturn based on any reasonable market valuation. As previously mentioned, we have more people working in America than ever today. Do you think for a second that they will cut back on their iPhone usage? Do you think that going forward we will have less use of the internet and therefore affect Google’s earnings? If you own Microsoft, Microsoft is basically a monopoly around the world. Everything you touch has Microsoft’s name on it.

With more people working than ever and a 5% increase in salaries over the last year, do you really think fewer people will be using Microsoft? All of those assumptions are ridiculous. Could in fact the Ukrainian War get more out of hand and create harm to the American economy? Of course, that possibility exists. However, it looks like Ukraine is well along the way to shutting down the Russian military and negotiating a settlement to the war before the end of December 2022. The question is, are we going into a recession in 2023 due to the actions of the Federal Reserve?

I don’t believe that the Federal Reserve would ever purposely destroy the economy in an effort to reduce inflation. Remember, we are also in a political environment where the next Presidential election is only two years away. There is a high likelihood that Washington will turn over during the midterm elections, which I think would be a positive for the markets going forward. The markets seem to do best when the government does less.

Long-time client Sookie Mitchem looking trés chic!

So, my projection of the increase in stock prices depends on the actions of the Federal Reserve and the traders. If the Federal Reserve would announce some sort of cutback or slow down on interest rate increases, you would see remarkably increased stock prices. We now know from all economic evidence, there is no reasonable reason that the market has fallen 23.9% year-to-date. But I also know that all these numbers could turn on a dime if the Federal Reserve were to indicate a moderation. What we know from prior bear markets are that they can all literally change overnight without any warning. If you are not invested, you will not enjoy that increase.

We also know from prior experience that this is the buying opportunity of a lifetime for people not needing the money for 10 years or so. Stocks are trading at huge discounts and if you are a young investor not needing your money for 20 to 30 years, you should take this opportunity to up your investment for the future. For people near retirement, the biggest misconception is that they believe they will need all of their money on day one. As an example, if you retire at age 65 and you have a life expectancy of 25 years, why do you want 100% of your investment money to be conservative? If in 19 years you will only have two negative years, and if you keep a couple of years of cash reserves to pay distributions, the rest of the money should be invested. I am not sure when exactly the traders will change their minds.

Drew Malone and his brother, Brock, lending a hand at the Falcons game!

You may have recently noticed that the major brokerage houses were fined close to $1.8 billion for traders using their own personal phones during working hours. As you well know, the SEC closely scrutinizes phone calls and emails regarding investing. They have no authority over text messages. It came out that all the major brokerage houses were allowing their traders to text during working hours. I rather suspect that is just the first start of this coalition of traders trying to manipulate the market. They all move in one direction at a time. But that one direction can change immediately with communication. There will be a day shortly where those traders decide that it is time to buy and the move up will be significant and rapid. I do not know when that day is, but I do know that if you are not invested, you will not participate.

I fully recognize that this has been a difficult year and selling to cash would be the easiest thing that I could do. It would take 100% of the stress off of me and 100% of the stress off of you. The problem with that action is that as every financial book will tell you, you never try to time the market. If we go to cash, which is a simple action, to get reinvested is a difficult reaction. I would rather take the risk that we suffer some short-term losses in order to participate in long-term opportunities. I know it has been difficult, but you have to believe that the economics overrides the performance of the traders, and this year will eventually work out fine.

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.