Hello friends, welcome to the November market outlook. Spooky season is over and we’re onto the holiday craze, albeit a slower craze than pre-Covid. Nonetheless, with the world on better footing with the virus, we hope you enjoy the holiday season and make time to reconnect with loved ones and friends that we haven’t seen for a long time; it really is the most wonderful time of the year. That said, let’s hope that’s true for markets as well. Although, as of this writing, we’re seeing pockets of weakness. The market has been on a tear since the beginning of October but the rally could be losing steam. We’ve mentioned breadth in the past, the number of stocks advancing vs. declining. When the market is advancing, you want to see more stocks making new highs. The opposite can often lead to a false signal and represent a fragile market being held up by only a few stocks. Well, on the day the NASDAQ has hit an all-time high, the advance/decline line shows 975 issues advancing and 2185 issues declining! Certainly does not sound like a broad advance.
We’re currently in the midst of earnings season. So far the results have been in-line or slightly better, but outside of a few tech moves, stock reactions have been muted. For the most part, what we’ve been hearing from CEOs and CFOs is troubling. Here’s Dallas based Kimberly Clark’s CEO talking about the current predicaments facing his organization- “I think the labor issues in the US are very real and that’s where we are feeling the brunt of the challenges on the supply chain side…and meaningful cost increases versus what we had been expecting in North America and that the labor market in the US, I just don’t see a near term catalyst, so I think the headwinds and the increased distribution costs will certainly be with us into 2022, and we’ll have to see all of this play out.” He continues from there, “our employee tenure has shortened dramatically, and so it’s changing how we staff because we have to staff more people to get the product out the door. We’ve got production outages, missed deliveries, and that ripples through with fines and everything else with customers.” This is just one example of many, similar sounding reports that can be found across the globe. At this point, investors and Main Street should be well aware of the pressures facing all types of businesses, large and small.
Let’s switch gears and talk about the global central banking community. For those unaware, multiple central banks have begun tightening policy due to the fear of inflation persisting longer than was previously thought. So far, there have been 20 rate hikes globally- Brazil, Russia, UK, New Zealand, Australia, Canada, Chile, Mexico, Norway, Peru, etc. have all tightened policy – and nothing from the Federal Reserve. It’s our opinion that the Fed has made, and is in the process of continuing to make, a policy mistake. The headline inflation rate in the US is at 5.4%, and the core inflation rate is at 4%. Both are at multi-year highs. As we know, the way we choose to measure inflation is skewed. In reality, inflation is probably closer to 7%, if not higher. Citigroup’s Global Inflation Surprise Index has risen to the highest level since 1999. Citigroup’s Global Economic Surprise Index has turned negative and has fallen to levels historically associated with an economic slowdown/recession. Speaking of slowdown, we just printed a weak 3rd quarter GDP number, and the expectations are that we will further slow as 2021 draws to an end. On the positive side, a few central bankers in the US have begun to change their stance and admit that inflation may persist longer than they previously expected. Moreover, it’s unbeknownst to us how keeping rates low remedies the supply chain dislocations we’re experiencing. But wait, remember the tales of bond vigilantes? Well, we’ve got a much larger player to worry about- the bond market, which could force the Fed’s hand and has already begun to do so. The bond market sent two worrisome signals recently. The rise of inflationary expectations, hinting that the Fed will begin tapering, and a slowdown in economic growth. It’s too early to call for stagflation- which would be the worst case scenario for the market. But, more likely, a sustained period of inflationary pressure with growth slowing below 2%. As we mentioned in our previous outlook, that would provide us with a less than optimal GDP. Growth isn’t just slowing here but globally as well. China is experiencing their slowest growth rate in more than a decade. Europe is close to recession once again. Moreover, the German economic minister recently said that hundreds of thousands of cars can’t be built due to chip shortages. We’ve said this in the past, but those who believe supply chains will be easily repaired are likely mistaken. We’ve heard from the likes of Cathie Wood that claim inflation will be transitory due to the disinflationary nature of technology. Our argument to her point, far less of the world is currently using EV, AI, energy storage, robotics, genome sequencing, and blockchain technology as compared with fossil fuels, internal combustion engines, toilet paper, food and housing. We agree that over time these technologies will be deflationary, but they do nothing to stop or reverse the course of present and increasing inflationary pressure. Also, a great deal of the deflationary period we experienced over the last 40 years was due to globalization. Yes, technology played a part, but most of it was due to moving labor and jobs overseas, allowing the American consumer to benefit from lower costing goods. As we now know, de-globalization has already begun via reshoring. Our cost of goods, as well as our labor, is increasing because of it. Tariffs by the previous administration brought over 100 trucking companies to bankruptcy. We’re now living with the ramifications of Fed policy mistakes, tariffs and de-globalization. That said, a tightening at this time could pose risk to global economic growth – from already slowing levels- the trajectory of which may be more fragile than the bullish crowd expects. If the Fed waits too long and expectations jump, it may instead have to raise rates higher much faster than they plan. In a worst-case scenario, where long-term inflation expectations hit 4%, the Fed could then have to go as high as 5-6% with the Federal Funds rate. We always feared the Fed having to choose between two bad decisions, it looks like we’ve arrived at that narrative.
On the political front, talks last week failed to reach agreement over tax measures to raise revenues for what could be $2 trillion in spending. The White House messaging has changed somewhat from one of big ambition to something closer to ‘something is better than nothing.’ It now seems almost certain that negotiations will continue past the stated deadline.
We don’t see any black swans on the immediate horizon, although Evergrande and China continue to bear watching. Growth stocks could be set to outperform value stocks over the short term due to the recent drop in real rates but medium and longer term, we expect value to continue to outperform growth. Portfolios should take advantage of any growth outperformance to rebalance to an overweight to value in their basket of stocks. Also look to add assets that will benefit in a rising interest rate environment- commodities and commodity producers, private credit and private alternatives, real assets and real estate. Be defensive and be nimble. As always, please reach out with any questions.
P.S. get your holiday shopping done early this year, unless you don’t mind swapping in the new year. You know, supply chain issues.
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