Hello friends, welcome to the September market outlook. We hope everyone enjoyed their summer and Labor Day weekend, boy did it all go by quickly. Fall has arrived along with sweatshirt season and football to look forward to. After that, the holiday craze will begin, so let’s enjoy the quiet season while we have it. Unfortunately, what might not be so quiet is volatility. As regular readers are aware, for the last few months we’ve expressed our view of a summer lull in the markets, followed by a period of volatility and pockets of weakness. Earlier this week, Goldman Sachs shared a similar view by cutting its forecast for 2021 growth, citing a reduction in consumer spending and the resilience of the delta variant. Any reduction in consumer spending will be noteworthy. Consumer spending accounts for 2/3rds of the U.S economy.
Switching to inflation, it’s starting to look far less transitory than officials had hoped for. Our view is that once inflation becomes unanchored, it’s very difficult to get under control. But let’s let the numbers do the talking. We started the year with a consumer inflation rate of 1.4%. This month, we hit 5.4%. This is a rate of inflation not seen in 13 years. Rents are rising at 17% annual rate which is adding angst to US households. S&P CoreLogic said its June home price index rose 19% year over year. That exceeds the biggest pace of gains in the mid 2000’s, a period that obviously didn’t end well. The Fed’s preferred measure of inflation (core PCE) has moved up to 3.6%, its highest level since 1991. The US Money Supply has increased nearly 40% over the last 2 years, its highest 2-year increase ever. And last but not least, here’s what Markit’s Index that covers small and medium size businesses had to say: “Manufacturers commonly reported that material shortages hampered output growth, as supplier delivery times increased markedly and to one of the greatest extents on record. Longer lead times were attributed to greater global demand for inputs and capacity issues at suppliers. Subsequently, cost burdens rose substantially in August. The rate of input price inflation was the fastest seen in more than 14 years of data collection amid supplier price hikes. In an effort to partially pass on greater costs to their clients, goods producers raised their selling prices at the steepest pace on record.”
The employment situation also saw an unfriendly report last week. Besides the small number of jobs created, the unemployment rate fell, along with average hours worked, but average hourly earnings (wage inflation) jumped higher. This number is very stagflationary and would bring on a very unfriendly market environment should it persist. In regards to how this affects consumer spending, well the enhanced unemployment benefits that many Americans were receiving just expired. In a period were prices advance exponentially, and growth slows, can the rate of US consumption remain intact?
Taking the present into account but imagining what the future holds for some companies is immensely important. Many market participants accept that stocks are expensive based on history but most rationalize today’s equity valuations as inexpensive relative to the current low level of interest rates which are a powerful factor of determining stock prices. After all, with today’s price earnings multiple of the S&P Index at about 23x, compared to the post-World War II average of 16x, the earnings yield (the inverse of the p/e ratio) is about 4.35% – and is still seemingly attractive relative to the 10 year U.S. note yield of 1.31%. But, if rates were to move higher, which most now expect, valuations would need to move lower. As an example, if rates were to move to say 2%, then the market multiple would have to be reset to 18x. That would be an unfriendly event for the high growth/tech companies and their investors as their stock prices would drop to meet the new valuation. On that note, FANGMAN is still eating the world. Combined mkt cap of US Big Tech (Facebook, Apple, Nvidia, Google, Microsoft, Amazon, Netflix) has hit a fresh all-time high of $10.3tn. Now, the opposite would be true if you believe that rates are headed back to 1%. In that environment FANGMAN and other growthy names will have their cash flows continue to be highly valued. The question to be asking, is the current environment potentially as good as it gets?
To close up, we’re not the only economy facing headwinds. Over the last few weeks China has seen growth materially slow, and their investors have been punished for it. Delta continues to spread, providing a governor to growth for most economies. But booster shots are on the way. So far, the studies on vaccines are showing tremendous results with 97% reduction in severe illness. The humanitarian crisis in Afghanistan continues to unfold. It’s still very unclear if there will be a market reaction, but so far it’s been ignored. We hope everyone has a great month and as always, please reach out with any questions.
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